Dying of Money: Lessons of the Great German and American Inflations

Dying of Money: Lessons of the Great German and American Inflations

Dying of Money: Lessons of the Great German and American Inflations

by Jens O. Parsson

Out Of Print! Orphaned Work! Not For Resale!

c 1974, Wellspring Press,

978-0914688013

ISBN

Boston

Contents 1 The Ascent

3

2 The Descent

9

3 The Gains and Losses

13

4 The Roots

17

5 Prosperity of 1920-1921

23

6 Politics

27

7 The Lessons

31

8 The War

37

9 Grappling with Stability

43

10 Prosperity of 1962-1968

47

11 The Inationary Syndrome

53

12 Culprits and Scapegoats

65

13 The Open Questions

73

14 Economic Theory

77

15 Prices

79

16 Ination

85

17 Velocity

89

v

18 Aggregate Values

95

19 Real Values

101

20 Government Debt

107

21 The Record Interpreted

111

22 Money

115

23 The Creation of Money

119

24 Depression

125

25 The Economics of Keynes

129

26 Inationary Economics

135

27 The Economics of Disaster

143

28 The Crux

147

29 Taxes

149

30 American Taxes

157

31 The National Dividend

167

32 Employment

175

33 Investment and Growth

185

34 Dogma

189

35 President Nixon Begins

201

36 Price Controls

207

37 The Way Out

215

38 The Way Ahead

223

39 Democratics

231

40 Political Reorganization

237

41 Self Defense

241

42 The Stock Market

247

43 A World of Nations

253

44 Interscript

261

vii

viii

Foreword Most of us have at least a general idea of what we think ination is. In ation is the state of aairs in which prices go up. Ination is an old, old story. Ination is almost as ancient as money is, and money is almost as ancient as man himself. It was probably not long after the earliest cave man of the Stone Age fashioned his rst stone spearhead to kill boars with, perhaps thirty or forty thousand years ago, that he began to use boar's teeth or something of the sort as counters for trading spearheads and caves with neighboring clans. That was money. Anything like those boar's teeth that had an accepted symbolic value for trading which was greater than their intrinsic value for using was true money. Ination was the very next magic after money. Ination is a disease of money. Before money, there could be no ination. After money, there could not for long be no ination. Those early cave men were perhaps already being vexed by the rising prices of spearheads and caves, in terms of boar's teeth, by the time they began to paint pictures of their boar hunts on their cave walls, and that would make ination an older institution even than art. Some strong leader among them, gaining greater authority over the district by physical strength or superstition or other suasion, may have been the one who discovered that if he could decree what was money, he himself could issue the money and gain real wealth like spearheads and caves in exchange for it. The money might have been carved boar's teeth that only he was allowed to carve, or it might have been something else. Whatever it was, that was ination.

The more the leader issued his carved boar's

teeth to buy up spearheads and caves, the more the prices of spearheads and caves in terms of boar's teeth rose. Thus ination may have become the oldest form of government nance. It may also have been the oldest form of political condence game used by leaders to exact tribute from constituents, older even than taxes, and ination has kept those honored places in human aairs to this day.

ix

Since those dim beginnings in the forests of the Stone Age, governments have been perpetually rediscovering rst the splendors and later the woes of ination. Each new government discoverer of the splendors seems to believe that no one has ever beheld such splendors before.

Each new discoverer

of the woes professes not to understand any connection with the earlier splendors. In the thousands of years of ination's history, there has been nothing really new about ination, and there still is not. Around the year

300

A.D., the Roman Empire under the Emperor Dio

cletian experienced one of the most virulent inations of all time. government issued cheap coins called washed with silver.

nummi,

The

which were made of copper

The supply of metals for this ingenious coinage was

ample and cheap, and the supply of the coinage became ample and cheap too. The nummi prices of goods began to rise dizzily. Poor Emperor Dio cletian became the author of one of the earliest recorded systems of price controls in an eort to remedy the woes without losing the joys of ination, and he also became one of the earliest and most distinguished failures at that eort. The famous Edict of Diocletian in

301 decreed a complex set of

ceiling prices along with death penalties for violators. Many death penal ties were actually inicted, but prices were not controlled. Goods simply could not be bought with nummi. Like every later eort to have the joys without the woes of ination, the Edict of Diocletian failed totally. So it has gone throughout the millenniums of man's development. For at least the four thousand years of recorded history, man has known ination. Babylon and Ancient China are known to have had inations. The Athe nian lawgiver Solon introduced devaluation of the drachma. The Roman Empire was plagued by ination and, more rarely, deation.

Henry the

Eighth of England was a procient inationist, as were the kings of France. The entire world underwent a severe ination in the sixteenth and seven teenth centuries as a result of the Spanish discoveries of huge quantities of gold in the New World.

Continentals

in the American Revolution and

the assignats in the French Revolution were precursors of the wild paper inations of the twentieth century.

Steadily rising prices have been the

general rule and not the exception throughout man's history. The twentieth century brought the institution of ination to its ultimate perfection.

When economic systems are so highly organized as they be

came in the twentieth century, so that people are completely dependent on money trading for the necessaries of life, there is no place to take shelter

x

from ination. Inations in the twentieth century became like inations in no other century. The two principal inations that occurred in advanced industrial nations in the twentieth century will probably prove to have done more to inuence the course of history itself than any other ination. One of these was the German ination that had its roots in World War I, grew to a giddy height and a precipitous fall in

1923,

and contributed to the

rise of Adolf Hitler and World War II. The other was the great American ination that had its roots in World War II, grew in the decade of the

1960's

toward an almost equally giddy height, and contributed to results

which could not even be imagined at the time this book was written. This book is not a history of ination, because most inations of history hold only a passing interest. This book is written primarily about the great American ination, and it was written at a time when that ination was still in mid-career. No one then knew where it might end, but it seemed altogether possible that no ination of history, not even the German, would appear in retrospect to have troubled the waters of time more deeply than the great American ination. Inations may be of every conceivable variety of degree, from the mildly annoying to the volcanic. Inations may be fast or slow, accelerating or decelerating, chronic or transitory.

A merely annoying ination usually

causes no one very much real harm.

A volcanic ination, on the other

hand, is the kind of catastrophe that conscates wealth, withholds the means of life, breeds revolutions, and precipitates wars.

Every volcanic

ination of history began as a mildly annoying ination. The true nature of any ination is not often visible on its surface. As with volcanoes, an annoying ination that is about to subside and die out looks on its surface like one that is about to erupt. It is the disquieting nature of an ination that no one knows with certainty what it will do next. The era of the ination in the United States was an era of many kinds of discomforts. The nation was ghting a small but dismal and unpopular war in distant Southeast Asia. Crime was rampant. Cities were degenerating. Negroes were in ferment, students in rebellion, and youth in general in a state of defection. The illness of ination might have been lesser or greater than any of these. It might have had nothing to do with any other illness, or it might have lain near the root of them all.

There were those who

dismissed the ination as the least of the panoply of American illnesses, but they were less numerous than formerly and might be still less numerous

xi

later. Scarcely a person in America was untouched by ination's handiwork. Every citizen, in his daily life and with his earthly fortune, danced to a tune he mostly could not hear, played for him by the government's ination. It was up to every citizen to learn for himself what was happening and to look out for himself if anyone was going to, because no one else was looking out for him. The government certainly was not. The government was compelled by its other duties not to protect him but the opposite, to continue to steal from him by the ination as long as it could. The forces at work were such that there was no practical possibility the ination would end or abate. The only real question was whether or not it would continue to become steadily worse. A hundred million Americans or more, almost all of them serenely unwitting, lived their lives and made their homes on ination's epicenter. They were on ground zero for ination's shock waves. Only time would tell whether the tremors rumbling beneath their feet would pass o without a quake. The past is prologue, it is said.

No more instructive prologue to the

American ination, which was still unnished, could be chosen than the German ination, which was long since completed. Let us begin then by turning rst to that ination and taking our text for the day from the scripture of history.

xii

PROLOGUE: The German Ination of 1914-1923

1

1 The Ascent In

1923

mark,

Germany's money,

the Reichs

nally was strained beyond the

bursting point, and it burst. Persistent in ation which had steadily eroded the mark since the beginning of World War I at last ran away. Germany's

disastrous prosperity

came to an end, and in its place the Ger man people suered a period of hardship and real starvation as well as a permanent obliteration of their life savings.

When

the debacle was nally stopped, the old mark, which had once been worth a solid

23 cents, was written o at one trillion old marks to one new one of the same par value. The most spectacular part of that loss was lost in the mark's nal dizzy skid; all the marks that existed in the world in the summer of enough, by November of

1923,

1922 (190

billion of them) were not worth

to buy a single newspaper or a tram ticket.

That was the spectacular part of the collapse, but most of the real loss in money wealth had been suered much earlier. The rst

90

percent of the

Reichsmark's real value had already been lost before the middle of

1922.

The tragicomic denouement of Germany's ination  the workers hasten ing to the bake shops to spend quickly their day's pay bundled up in billions of paper marks and carried in wheelbarrows  is perhaps at least vaguely remembered nowadays. The more sinister and more permanent scars which the ination left are less well known. Still less clearly remembered are the years before the mark blew, with their breakneck boom, spending, prots, speculation, riches, poverty, and all manner of excess. Throughout these years the structure was quietly building itself up for the blow. Germany's ination cycle ran not for a year but for nine years, representing eight years of gestation and only one year of collapse.

3

1 The Ascent The beginning was in the summer of

1914,

a day or two before World

War I opened, when Germany abandoned its gold, standard and began to spend more than it had, run up debt, and expand its money supply. The end came on November

15, 1923,

the day Germany shut o its money

pump and balanced its budget. Over the nine years in between, Germany's ination followed not a constant course but a characteristic ascent and descent, a ripening and a decay. Germany started by not paying adequately for its war out of the sacrices of its people  taxes  but covered its decits with war loans and issues of new paper Reichsmarks. Scarcely an eighth of Germany's wartime expenses were covered by taxes. This was a failing common to all the combatants. France did even worse than Germany in nancing the war, Britain not much better. Germany's bad nancing was due in part to a rm belief that it would be able to collect the price of the war from its enemies, whom it expected to defeat; but to a greater degree it may have sprung from distrust that its people would support the war to the extent not only of ghting it but also of paying for it.

Whatever the reason, Germany's bad war

nancing did not immediately demand its price. Ination in the sense of rising prices was moderate. Domestic prices only a bit more than doubled to the end of the war in

1918,

while the government's money supply had

increased by more than nine times. The government's debt increased still more. So long as the government in this way could spend money it did not have faster than its value could fall, Germany had both its war and life as usual at the same time, which was the same as having the war free of charge. After the war, Germany and all the other combatants underwent price inations which served as partial corrections for their wartime nancing practices. The year

1919

was a year of violent ination in every country,

including the United States.

By the spring of

1920,

German prices had

reached seventeen times their prewar level. From this point, however, the paths of Germany and the other nations diverged. The others, including the United States, stopped their decit nancing and began to take their accumulated economic medicine by way of an acute recession in

1921.

Their prices fell steeply from the

1920

1920

and

level. Germany alone contin

ued to inate and to store up not only the price of the war but also the price of a new boom which it then commenced enjoying.

Germany's re

markable prosperity was the envy of the other leading countries, including

4

the victors, who were in serious economic diculties at the time. Prices in Germany temporarily stabilized and remained rock-steady during fteen months in

1920

and

1921,

and there was therefore no surface ination at

all, but at the same time the government began again to pump out decit expenditure, business credit, and money at a renewed rate.

Germany's

money supply doubled again during this period of stable prices.

It was

this time, when Germany was sublimely unconscious of the scal monsters in its closet, which was undoubtedly the turning of the tide toward the inationary smash. The catastrophe of

1923

was begotten not in

1923

or

at any time after the ination began to mount, but in the relatively good times of

1920

and

1921.

The stimulation of the government's easy money spread through virtually all levels of the German economy. The life of the ination in its ripening stage was a paradox which had its own unmistakable characteristics. One was the great wealth, at least of those favored by the boom. These were the

proteers

of whom everyone spoke. Industry and business were going at

fever pitch. Exports were thriving; that was one of the problems. Hordes of tourists came from abroad. Many great fortunes sprang up overnight. Berlin was one of the brightest capitals in the world in those days. Great mansions of the new rich grew like mushrooms in the suburbs. The cities, particularly in the eyes of the austere country folk, had an aimless and wanton youth and a cabaret life of an unprecedented splendor, dissolution, and unreality. Prodigality marked the aairs of both the government and the private citizen. When money was so easy to come by, one took less care to obtain real value for it, and frugality came to seem inconsequential. For this reason, Germans did not obtain so much real wealth as the growth of money alone would have indicated. Side by side with the wealth were the pockets of poverty. Greater num bers of people remained on the outside of the easy money, looking in but not able to enter. The crime rate soared. Although unemployment became virtually nonexistent and many of the workers were able to keep up with the ination through their unions, their bargaining, and their cost-of-living escalator clauses, other workers fell behind the rising cost of living into real poverty.

Salaried and white-collar workers lost ground in the same way.

Even while total production rose, each individuals own eorts faltered and showed a measurable decline, and the quality of production deteriorated. Accounts of the time tell of a progressive demoralization which crept over

5

1 The Ascent the common people, compounded of their weariness with the breakneck pace, to no visible purpose, and their fears from watching their own pre carious positions slip while others grew so conspicuously rich. Feelings of disunity and dissent were epidemic among the Germans, and nationalism among them was never weaker. Regional separatism was so strong that it came close to breaking up Germany into fragments. Along with the paradoxical wealth and poverty, other characteristics were masked by the boom and less easy to see until after it had destroyed itself. One was the dierence between mere feverish activity, which did certainly exist, and real prosperity which appeared, but only appeared, to be the same thing. There was no unemployment, but there was vast spurious em ployment  activity in unproductive or useless pursuits. The ratio of oce and administrative workers to production workers rose out of all control. Paperwork and paper workers proliferated. Government workers abounded, and heavy restraints against layos and discharges kept multitudes of re dundant employees ostensibly employed. The incessant labor disputes and collective bargaining consumed great amounts of time and eort. Whole industries of fringe activities, chains of middlemen, and an undergrowth of general economic hangers-on sprang up. Almost any kind of business could make money. Business failures and bankruptcies became few. The boom suspended the normal processes of natural selection by which the nonessen tial and ineective otherwise would have been culled out. Practically all of this vanished after the ination blew itself out. Speculation alone, while adding nothing to Germany's wealth, became one of its largest activities.

The fever to join in turning a quick mark

infected nearly all classes, and the eort expended in simply buying and selling the paper titles to wealth was enormous. Everyone from the elevator operator up was playing the market. The volumes of turnover in securities on the Berlin Bourse became so high that the nancial industry could not keep up with the paperwork, even with greatly swollen stas of back-oce employees, and the Bourse was obliged to close several days a week to work o the backlog. Another busy though not directly productive sector of activity was in capital goods and industrial construction. The boom's excessive emphasis on producing new means of production was striking. Travelers remarked the contrast between Germany's new, humming factories and the old, de pressed ones of neighboring countries. Much of this indiscriminate growth

6

in plant capacity made sense only in the bloated inationary expansion, but not otherwise. After the ination ended, much of Germany's brand new in ation-built plant was "rationalized," which often meant simply torn down again. Concentration of wealth and business was still another characteristic trend. The merger, the tender oer, the takeover bid, and the proxy ght were in vogue.

Bank mergers were all the rage, while at the same time

new and untried banks sprouted.

Great ramshackle conglomerates of all

manner of unconnected businesses were collected together by merger and acquisition.

Armies of lawyers, brokers, accountants, businessmen, and

technicians who spent their time pasting together these paper empires bol stered the lists of the more or less employed.

The most fabulous of the

conglomerates was the empire of Hugo Stinnes, which comprised hundreds of companies at its peak in coal, iron, steel, shipping, transport, paper, chemicals, newspapers, oil, lms, banks, hotels, and more.

Stinnes was

Mr. Everything who had also begun to colonize abroad and is supposed to have contemplated organizing all German industry into a single super- conglomerate. After the ination ended, Stinnes' empire and many lesser ones were found to be functionally and nancially unsound, and they dis integrated more or less messily. Stinnes died. It was typically true that the Germans who grew the richest in the ina tion were precisely those who, like the speculators, the operators, and the builders of paper empires, were least essential to German industry operat ing on any basis of stability or real value. With the end of the ination they disappeared like apparitions in the dawn, and scarcely a one of the "kings of ination" continued to be important in German industry afterward.

7

1 The Ascent

8

2 The Descent

T

hat was how it was in the heyday of the boom, which was the ripen

ing stage of the ination. Inexorably the ination began to stalk the

boom. From having been steady during the fteen months preceding July

1921,

prices doubled in the next four months and increased by ten times in

the year through the summer of strikes against the rising prices.

1922.

Consumers put on pathetic buyers'

Interest rates soared as lenders tried to

anticipate the loss of value of their principal. Businessmen quoted prices to one another with gold or constant-value clauses, or they did business in foreign currency. The government's actual decits were relatively innocu ous. In fact, the government's budget was closer to balance at the brink of the crash in

1922

than at any time since

1914.

But while the govern

ment's new decits diminished, the ination had become self-sustaining, feeding on the old ones. The government was unable to renance its ex isting debts except by printing new money. The government's creation of paper wealth steadily fell behind the rising prices, and the ination entered its catastrophic decaying stage. The nal convulsion when it began was at rst bizarre and at last became sheer nightmare. Beginning in July

1922, prices rose tenfold in four months, 1923, prices were at

two hundredfold in eleven months. Near the end in

least quadrupling each week. Prices raced so far ahead of the money-print ing plants that, in the end, the total real value of all the Reichsmarks in the world was smaller than it had ever been, a phenomenon which enabled the government's economists to argue that there was no true ination at all, it was just numbers.

This phenomenon also made money so scarce,

even in the face of astronomical prices, that urban Germans could not nd the price of their daily bread. The worker had to compute his pay in the trillions, carry it in bales, and spent it instantly lest he lose it. The forlorn buyers' strikes of earlier days against the mildly higher prices were no more; in their place the buyers were vying with one another to buy up any kind of goods at any price before their little money could evaporate. The seas

9

2 The Descent of marks which had been stored up by Germans and especially by trusting foreigners ooded forth and fought to buy into other investments, foreign currencies, tangible goods, almost anything but marks. Legally "fair" in terest rates reached as much as dinner might rise

22 percent per day.

The price of a schnitzel

20 percent between giving the order and paying the check.

Germany's money printing industry (another impressively large employer with

30

paper mills,

133

printing plants, workers in thousands) could not

turn out enough trillions to keep up.

States, towns, and companies got

into the act by issuing their own "emergency money" (Notgeld).

Barter

became prevalent. Still money grew scarcer while prices continued to soar. The boom was long since over.

Farmers, who were comfortable enough,

would not sell their food to the townsmen for their worthless money. Star vation and abject poverty reigned. The middle class virtually disappeared as professors, doctors, lawyers, scientists and artists pawned their earthly goods and turned to eld or factory to try to earn a little food. A former conductor of the Boston Symphony Orchestra earned a dollar's worth of trillions a week conducting an orchestra in North Germany.

Every level

of life above the barest existence was shed. Malnutrition and the diseases of malnutrition were rife.

Production began to fall.

As factories closed,

the workers too became unemployed and joined the starving. The whole system ground to a halt. Food riots and Marxist terror broke out through out Germany. Eighty-ve persons died in a riot in Hamburg. The famous beer hall Putsch led by Adolf Hitler in Munich in November

1923,

the last

month of the ination, was only one of the many and not the worst. Once the old Reichsmark had been thoroughly obliterated, the return to a stable currency was so absurdly simple as to become known as the "miracle of the Rentenmark." The Rentenmark, or "investment mark," was the new interim currency.

The government of industrialist Wilhelm Cuno, which

had ruled during most of the worst of the ination, nally fell in August of

1923.

Gustav Stresemann, who was later foreign minister throughout

the trying

1920's

and has been described as by far the greatest German of

the Weimar era, was promptly summoned as chancellor. In October, the Reichstag voted him dictatorial powers under the Weimar constitution. He in turn called upon Dr. Hjalmar Schacht, who was later Hitler's nancial wizard and was tried (but acquitted) at Nuremberg, as the commissioner for the new Rentenmark.

As Dr.

Schacht relates, he accomplished the

introduction of the Rentenmark with no sta but his secretary and no

10

establishment but his dark back oce and a telephone. The Rentenmark was placed in circulation beside the devalued Reichsmark and carried no real value of its own but the naked avowal that there would be only so many Rentenmarks and no more. The Germans miraculously believed it and, still more miraculously, it turned out to be true. The old Reichsmark was nally pegged at one trillion to one Rentenmark on November

15, 1923;

simultaneously the German nance ministry under the estimable Dr. Hans Luther, who was to become chancellor of one of the later governments, balanced its budget, and that was the end of the ination. Stabilization through the Rentenmark was by no means painless. To convince the skeptical required rst a series of severe bloodlettings administered by the resolute Dr.

Schacht to foreign-exchange specu

lators, issuers of the Notgeld, and busi nesses which required credit, all of whom depended on the continued depreciation of the ocial currency. When the president of the Reichsbank throughout the war and the ination, Rudolf Havenstein, died at the moment of the stabilization, Schacht was appointed to succeed him. Schacht's greatest achievement was not so much in the introduction of the Rentenmark but in making a new non-inationary money pol icy stick.

The grand-daddy of all credit

squeezes ensued from Dr. Schacht's order of April all credit from the Reichsbank.

7, 1924,

which stopped

New ination, which had begun to stir

again, was then abruptly and nally stopped. The entrenched interests in Germany, especially the industrialists like Stinnes, characteristically fought Schacht every inch of the way, although a few later acknowledged the tight ness of his course. Germany now took its stored-up dose of hard times. Germans who had been caught in the ination were relieved of their worldly goods. Businesses which were based on nothing but the inationary boom were swept away. Credit for business was practically impossible to come by. Unemployment temporarily skyrocketed. Government spending was slashed, government

11

2 The Descent workers dismissed, taxes raised, working hours increased, and wages cut. Almost

400,000

government workers alone were discharged. The shock to

the German people of the nal ination, the stabilization, and the unem ployment was so great that in the elections of May

1924,

six months after

the close of the ination, millions of voters ocked from the moderate cen ter parties to either the Communists or the Nazis and Nationalists on the extremes. These parties gained dramatic strength in the "ination Reich stag," as it was called. Germany very quickly began to feel better economically, however, as the stabilization medicine did its work. New elections only seven months later, in December

1924,

repudiated the Nazis and Communists and restored the

strength of the middle-class parties and of the Social Democrats, the ortho dox labor party. Only by the greatest eorts did Germany get itself going again in this way. Even so, because of the permanent shortage of credit Ger many's revival was unhealthily based (against Schacht's warnings) on new foreign loans. The world depression which followed

1929

Germany at again, and Hitler followed close behind.

12

knocked debtor

3 The Gains and Losses When the ination was over, everyone who had owed marks suddenly and magically owed nothing. This came about because every contract or debt that called for payment in a xed number of marks was paid o with that many marks, but they were worth next to nothing compared with what they had been worth when they had been borrowed or earned. Germany's total prewar mortgage indebtedness alone, for example, equal to

40

billion

marks or one-sixth of the total German wealth, was worth less than one American cent after the ination. On the other side, of course, everyone who had owned marks or mark wealth such as bank accounts, savings, insurance, bonds, notes, or any sort of contractual right to money suddenly and magically owned nothing. The largest gainer by far, because it was the largest debtor, was the Re ich government. The ination relieved it of its entire crushing debt which represented the cost of the war, reconstruction, reparations, and its decit- nanced boom. Others who were debtors emerged like the government with large winnings. Until the last moment of the ination borrowers continued to make huge prots simply by borrowing money and buying assets, because lenders never stopped underestimating the ination. The good fortune of the debtors demonstrated the prudence of following the government's lead: one must beware of being a creditor whenever the government was a huge debtor.

Farmers in particular were the classic case of invulnerability to

ination, because they always had food, their farms were constant values, and the many who had mortgages on their farms were forgiven their debts outright. The debtors' gain was the creditors' loss. Foreign holders of marks were huge losers.

Germany was estimated to have made a prot of about

billion gold marks, or

40 percent of its annual national product,

15

on sales of

its paper marks to foreigners, even after deducting reparations payments. The wealthy in Germany suered heavily but unevenly; the more nimble perceived early enough the need to invest in something other than mark

13

3 The Gains and Losses wealth, while those who were not nimble lost everything. Trustees were for bidden by law until the very end to invest in anything but xed obligations and consequently lost all the value of their trusts. The endowments of great charitable institutions, similarly invested, were wiped out. Financial insti tutions such as banks and insurance companies, which were both debtors and creditors in marks, were generally weakened though not destroyed in the ination because of their inability to see clearly what was happening. Speculators tended to believe in their own game until too late and emerged as net losers. Sound business escaped weaker but intact; their debts were relieved but their boom business was gone. Ination-born businesses dis appeared. Industrial stocks, the darling of the inationary speculation, had a pe culiar history. At the height of the boom, stock prices had been bid up to astronomical price-earnings ratios while dividends went out of style. Stock prices increased more than fourfold during the great boom from February

1920

to November

1921.

Then, however, shortly after the rst upturn of

price ination and long before the inationary engine faltered and business began to weaken, a stock market crash occurred. This was the Black Thurs day of December

1,1921.

Stock prices fell by about

25

percent in a short

time and hovered for six months while all other prices were soaring. The real value of stocks declined steadily because their prices lagged far behind the prices of tangible goods, until for example the entire stock ownership of the great Mercedes-Benz automobile manufacturer was valued by the mar ket at no more than

327

cars. Investors were extremely slow to grasp that

stocks were poles apart from xed obligations like bonds, quite wrongly thinking that if bonds were worthless stocks must be too. Nearer the end in

1923,

relative prices of stocks skyrocketed again as investors returned to

them for their underlying real value. Stocks in general were no very eec tive hedge against ination at any given moment while ination continued; but when it was all over, stocks of sound businesses turned out to have kept all but their peak boom values notably well. Stocks of ination-born businesses, of course, were as worthless as bonds were. The mass of the workers who lived mostly on their current wages, and who had no savings to lose, suered only temporarily with privation and unemployment in the very last throes of the ination; but these problems passed and left them where they had been or not much behind. To them, the agony of the ination was largely someone else's, just as the boom had

14

been. At bottom, it was the unsuspecting middle class who were Germany's savers, pensioners, purchasers of life insurance, including everyone from workers who saved to the modestly well-o, who not only suered the worst of the agony while the ination lasted but also were left after it was over with the most staggering permanent loss in relation to their whole substance. This class paid the piper for all of Germany. Great numbers of pensioners were left totally impoverished and forced back into the work gang to end their days there. The encouragement to thrift, an old German weakness, turned out to have been a complete swindle. Instead of a levy on all the Germans to pay for Germany's indulgences, a levy which might have been heavy but could have been fair, Germany left the levy to fall on those who were too innocent to evade it, and from them it took everything they owned. In any case, it was not the piper who went unpaid. The eect was a conscatory tax on these victims.

John Maynard

Keynes, who later rightly or wrongly was adopted as patron saint by ina tionary governments, excoriated them on this occasion: Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of ination, governments can conscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they can not only conscate, but they conscate arbitrarily . . . Adolf Hitler, whose economics were far more astute than those of the gov ernment's economists, shared roughly the same view of the inationary government conscators with Lord Keynes: . . . once the printing presses stopped  and that is the pre requisite for the stabilization of the mark  the swindle would be at once brought to light . . . the State itself has become the biggest swindler and crook. Despite the obliteration of the wealth of millions of individual Germans, the ination was merely a transfer of their wealth, like any tax, and not in any sense a destruction of wealth. For every German's total loss, there was an equivalent gain to some other German debtor or to Germany as a whole, through the discharge of their debts.

15

3 The Gains and Losses

16

4 The Roots The expansion of Germany's Reichsmark circulation, that is to say its money supply, always led the way in the ination. When it abated tem porarily, the ination abated temporarily. When it stopped permanently, the ination stopped permanently. Nevertheless, the ination was ocially blamed on everything under the sun but the government's spending, its decits, and its money issues.)

These, the government economists said,

followed and did not lead the ination.

According to their theories, the

money supply must increase to meet increasing needs (rising prices and expenditures) and not needs t themselves into existing supply. The gov ernment nances could not be put right, they said, until the price increases and the fall of the mark stopped. These in turn were generally attributed to external factors such as war reparations, balance of payments decits, the constantly declining foreign-exchange value of the mark, the proteers who were raising prices, foreign and domestic speculators who were supposedly attacking the mark, and the upward spiral of wages and prices. As for the proteers, Lord Keynes for one discredited the accusations: These proteers are, broadly speaking, the entrepreneur class of capitalists, that is to say, the active and constructive el ement in the whole capitalist society, who in a period of rapidly rising prices cannot help but get rich quick whether they wish it or desire it or not . . . By directing hatred against this class, therefore, the European Governments are carrying a step fur ther the fatal process which the subtle mind of Lenin had con sciously conceived. The proteers are a consequence and not a cause of rising prices. As for speculators, the most extraordinary feature of the Reichsmark's joyride was not any attack against it but quite the opposite, an incredible ("pathological," it was later called) willingness on the part of investors at home and abroad to take and hold the torrents of marks and give real

17

4 The Roots value for them. Until

1922 and the very brink of the collapse, Germans and

especially foreign investors were absorbing marks in huge quantities. Only the international reputation of the Reichsmark, the faith that an economic giant like Germany could not fail, made this possible. The storage factor caused by the investor's willingness to save marks kept the marks from being dumped immediately into the markets, and thereby for a long while held prices in check. The precise moment when the ination turned upward toward the vertical climb was undoubtedly timed by no event but by the dawning psychological awareness of the German and foreign investor that Germany was not going to back its money. With that, the rush to get out of the mark was on. Like a dam bursting, the seas of marks ooded into the markets and drove prices beyond all bounds. The German government strove mightily to outood the sea. The balance of payments problem was similarly misinterpreted. It was true that Germany had one. More of its cheap money was going out than hard money was coming in, in spite of constantly rising exports and con stantly falling imports.

This payments decit actually helped hold the

ination problem at bay, because it kept the pressure of Germany's cheap ening Reichsmarks o its own markets and prices.

The existence of the

payments decit was an accurate indicator that Germany, while sick, was not yet dying. The reversal of the payments decit was a sure signal that the end was near. In the collapsing stages, Germany ran a huge payments surplus as all her worthless marks came home from abroad in search of something to buy. This reversal of the balance of payments toward surplus was therefore not an occasion for hope, but for deepest fear. The chronic fall of the Reichsmark's foreign exchange rate against other world currencies was a striking phenomenon of the German ination. At that time, unlike the era after World War II, there was a free and uncon trolled market in foreign exchange, and every nation's currency was free to rise or fall as sharply and as far as the forces of supply and demand in the marketplace might dictate. Under these circumstances, the German mark was almost always falling, and it almost always had a considerably lower foreign exchange value than its internal purchasing power within Germany. This merely meant that the foreign exchange rate was a much quicker and more sensitive indicator of the ination of the mark than internal prices were.

The undervaluation of the mark in foreign exchange as compared

with internal prices had the eect of making German exports abnormally

18

competitive.

German exports increased and imports decreased continu

ously throughout the ination. Other nations tfully took steps to defend themselves from being ooded with cheap German exports. The eect of these unnaturally cheap exports on the German nation as a whole was sim ply to give away to other nations, without adequate return, a considerable portion of the fruits of the nation's eort. It has been estimated that Ger many lost

10 billion gold marks, or 25 percent of a year's national product,

on sales of under priced exports in the ination. The fall of the mark in foreign exchange preoccupied all the Germans, especially in view of Ger many's dire need of foreign exchange to pay reparations.

The Germans

habitually said that the inationary money issues could not be stopped until the mark stopped falling, but this of course was trying to stop the result before touching the cause. The war's eects were unusually malignant forces in Germany after the war. First there was economic reconstruction, not as dicult a problem as after the ravages of World War II. After that came the reparations, some thing that the second war fortunately did not see repeated. The Treaty of Versailles and the demands made under it by the victorious allies, especially France, for reparations beclouded the entire postwar era. Lord Keynes in a famous

1920

polemic against the treaty proclaimed the insanity of the

reparations policy. The Allies' rst rm bill for reparations, presented in May of

1921,

amounted to the fantastic sum of

132

billion gold marks.

This was about four times Germany's maximum annual national product and greater even than Germany's entire national wealth; it was like asking the United States in

1973

over a period of years.

to pay more than four trillion dollars in gold

There was much struggle over this preposterous

demand during the succeeding year, until nally the French army occupied the German Ruhr in January of

1923

in an eort to enforce the demand.

German passive resistance to the French occupation hampered Germany's economic machine for most of the remainder of

1923.

Germans liked to point to reparations jointly with the fall of the exchange as the cause of the ination.

Some outside observers also give credence

to the proposition that the reparations demands drove down the foreign exchange and forced Germany to issue inated money. But the fact is that Germany never paid in reparations anything like what the allies demanded. In the entire period from the end of the war until the end of the ination, the Germans paid only a paltry

2.4 billion gold marks in reparations, which

19

4 The Roots was about ve percent of a year's national product and less than Germany later paid in a single year under the more benevolent Dawes Plan. Germany paid no reparations at all for more than a year from September

1922

to

the end, while the ination was at its worst. Foreigners actually lost six or seven times more on the billions of worthless marks they acquired than Germany paid in reparations, so that Germany had a goodly net prot from foreigners as a whole in the ination. Germany unquestionably could have paid the trivial amount of its actual reparations without destroying its money. If reparations were any cause of ination, they were perhaps a psychological but not an economic cause. Germans' resentment against the reparations may explain why they lacked the will, though not the power, to keep their money hard and pay their debts out of sacrices. Germans may subconsciously have felt they had to bring their economy to utter collapse, irrelevant as that was, in order to dramatize their claim of inability to meet the Allies' preposterous demands; if so, the economic slaughter of the innocents in Germany was a high price to pay for dramatization. (The upward spiral of wages and prices in pursuit of one another is an other convenient scapegoat which the government seems to blame in every ination, and the German ination was no exception Karl Helerich, who as we shall see was the one man probably most responsible for the German ination, best summarized the government's professions of helplessness be fore the wage-price spiral, even while freely admitting that stopping the money creation would automatically have stopped the ination. His apolo gia will ring strangely familiar to anyone who has ever listened to any government explaining away any ination: But claims were put forward and eectively pressed to raise the standard of comfort and at the same time to reduce the intensity of labour. This could have but one result  a race between wages and prices such as we have witnessed in the last few years. The social and political position of labour was su ciently strong to enforce higher wages notwithstanding the fact that less work was done. As the prots of capital had shrunk to a minimum, the higher wages could be paid only if higher prices were obtained for the products. But higher prices raised the cost of living and brought about fresh demands for higher wages, which in turn led to a further rise in prices. And what was the part played by money in this vicious circle? The race

20

between wages and prices gave rise to a corresponding increase in the demand for money, both on the part of the people and on that of the nancial administration of the State. A monetary organization which oered resistance to such an expansion of monetary demand would thereby have put a stop to the race between prices and wages. The acute shortage of money would have brought about a collapse of wages and prices, probably accompanied by crises and catastrophes.

The German mone

tary system, however, makes possible in practice an unlimited expansion of the circulation, and it oered no such resistance. The monetary machine and its working, therefore, aided in the development pursued by wages and prices, but only in a sec ondary and passive manner. The increase in the issue of paper money is, within this complex of phenomena, not the cause but the consequence of rising prices and wages. At the same time, the fact that it was possible for paper money to be issued in unlimited quantities provided, the necessary condition for un limited increases in prices and wages.

(Emphasis added)

The government, condently convinced of its claim that the ination was being forced on it by external forces beyond its control, tried the usual array of palliatives to stanch the hemorrhages, such as import and export controls, exchange controls, and price controls. As always, these measures found no success.) They did achieve some rather strange distortions within the economy. Rent control was a conspicuous example. Rent control was eective enough so that the real cost of housing virtually disappeared from German budgets, the property of landlords was de facto conscated for the benet of tenants, and the housing shortage predictably became extreme. The government appealed to voluntary restraint and even to patriotism when the ight from the mark assumed the proportions of a panic.

It

characterized as practically traitorous those little citizens who, long after the smart money and far too late to save much, nally repented of their faith in the government and joined the stampede to get out of the mark. The government also tried one or two measures which did work but could not be continued. One was to stop the money and credit. This was done in late

1921, and the mark began to harden instantly.

But the resulting credit

squeeze began to strangle the boom equally fast, and business screamed.

21

4 The Roots The plain fact was that the boom could not live without the ination, and the fearful pains of withdrawal from the ination did not then appear necessary or inevitable. Easy money resumed and accelerated and never stopped again until the bitter end. The government tried supporting the mark with the Reichsbank's gold reserve early in

1923.

This too worked magically while it lasted, but as

long as the government continued to pump out new money with the other hand it merely lost its gold. That likewise quickly came to an end.

22

5 The Great Prosperity of 1920-1921 It is impossible to overemphasize the importance to Germany's collapse of the period from about March of

1920 to the end of 1921, in which Germany

was feeling quite healthy and prosperous while the rest of the world was enduring a severe recession.

Prices in Germany were steady, and both

business and the stock market were booming.

The exchange rate of the

mark against the dollar and other currencies actually rose for a time, and the mark was momentarily the strongest currency in the world. From the rst moment of this prosperity, however, Germany had already embarked on a new monetary ination which bought the boom. Germany's fate was thus already chosen at the moment when the boom began, and it was gradually sealed as the boom progressed. The route to Germany's inationary destiny may be traced out in the epic conict between two men, Karl Helerich and Matthias Erzberger. Helerich must be identied as the chief architect of Germany's economic disaster. He was minister of nance and vice-chancellor during the war, and he was directly responsible for the war policy of not paying for the war but rather saving up the cost to be collected from Germany's defeated enemies. He also had great personal inuence in later administrations that failed to deal with the ination. Helerich was neither a fool nor a political hack. To the contrary, he was a brilliant monetary theorist whose stature was compared, with some validity, to that of Lord Keynes. His ponderous trea tise on money, Das Geld, translated, was still in print in the United States as late as

1973, and a reading of his book is convincing proof of Helerich's

intellectual capabilities. Ironically enough, after contributing the most to the destruction of the mark, Helerich also made the principal theoretical contributions to the formation of the miraculous Rentenmark plan which ended the ination. As his book demonstrates, Helerich knew perfectly well the relationship between money creation and price ination; but, he

23

5 Prosperity of 1920-1921 said in substance, under the circumstances in Germany nothing could be done about it. money.

Germany had to create money because Germany needed

Helerich's abysmal failure in the German ination represented

more than anything else a tragedy of pure intellect, for he was constantly resorting to the most nely-reasoned theorization for answers that ignored simple observation of the facts. Helerich illustrates the dangers of allowing pure intellect to rule practical government policy. Helerich was described as cold, arrogant, pharisaical, moralistic, and intolerant, and he had the most supreme disdain for the mere politicians with whom he had to deal in the government. Helerich also was a scion of the arch-reactionary Na tionalist party which had been most warlike before and during the war, and was most irreconcilable to either democracy or cooperation with the victors after the war. The fatal sin of Helerich and all the Nationalists was that they would not bow to anything, certainly not to mere reality; if their intransigence spelled the destruction of the Reichsmark and all the little Germans, so be it. Matthias Erzberger was a bourgeois and a mere politician who sprang from the Catholic Center party. Like others (notably Gustav Stresemann) who later became the leading German moderates, he had been as enthusi astic an annexationist at the beginning of the war as the Nationalists. This merely reected the monumental folly which infected all the belligerents, including France, Britain, and Russia along with Germany and Austria, all of whom marched gaily into that hell with hearts high and all ags ying. Men like Erzberger and Stresemann were capable of change, as others like Helerich were not.

Erzberger became a leader of the peace movement

and a signatory of the Treaty of Versailles, for which reactionary Germany never forgave him. Erzberger was described as blunt, tactless, and impul sive. Erzberger and Helerich were imbued with a mortal personal hatred of one another dating from long before the war. Erzberger became minister of nance in June of

1919

in the rst post

war government of Gustav Bauer. Erzberger confronted the German war debt of

153

billion marks, which was considerably greater than Germany's

annual national product, and he resolved to try to make good on it. From then until early in

1920 he introduced a program of tax reforms and tremen

dously increased taxes, especially taxes on capital. Opposition from prop ertied interests was naturally enormous. Erzberger's principal opponents were Helerich himself and Dr.

24

Johannes Becker, a crony of Helerich's

who later as minister of economics was principally responsible for the mis erable failure of the Cuno government to do anything eective about the collapsing ination from

1922

through

1923.

Erzberger succeeded in forcing his taxes upon the nation, and as a result Germany's real tax yield in

1920

was the highest of any year from the

beginning of the war to the end of the ination.

At the same time, the

Reichsbank was induced to follow a tight money policy for an extended period in the latter part of

1919,

the only time during the entire nine years

in which the German money supply stopped rising for more than a month or so. Because of the skyrocketing price ination during

1919,

the money

supply was increasing much less rapidly than prices throughout this time. By March of

1920,

the enormous price increases of the preceding year had

brought Germany's price level to about seventeen times the prices of

1914.

As a result, the price level had increased by a factor roughly comparable to that of the money supply, and accordingly a temporary new equilibrium had been achieved and the ination was stopped. For well over a year, the price ination then remained stopped.

The real burden of the war debt

had been cut by ve-sixths as a result of the price ination of spring of

1919.

By the

1920, therefore, Germany was in a position to build on a stabilized

foundation. Meanwhile, public verbal warfare between Erzberger and Helerich rose to a crescendo.

Erzberger quite accurately denounced Helerich for be

ing the man most responsible for the ination and Germany's nancial plight; he also quite accurately accused Germany's industrialists like Hugo Stinnes for being at the bottom of Germany's political inability to put  nancial matters to rights. Helerich and the industrialists thundered back at Erzberger. Helerich lured Erzberger into a libel suit against Helerich. As usually happens in libel suits, it was quickly the plainti Erzberger who was on trial. The issues were mainly certain alleged improprieties and con icts of interest in Erzberger's private dealings with businessmen while in oce. On March

12, 1920,

the court returned its judgment and said that

Erzberger was guilty of some of the improprieties, imprudences, and care lessness that Helerich had alleged, although without evident corruption or personal gain. Helerich was also found to have libeled Erzberger and was levied a small ne, but he had won.

Erzberger was ruined, and he

immediately resigned from the government. This very day of March

12, 1920,

may be taken as Germany's turning

25

5 Prosperity of 1920-1921 point, for from this day her crusader for nancial probity was gone. This was also the very month in which Germany's prices at last stopped rising, the very month in which Germany's ination had nally been stabilized by the eective measures urged by Erzberger over the preceding year. This too was the month in which Germany's boom prosperity began, and it lasted for more than a year. Prices remained passive, the exchange value of the Reichsmark rose, and the German stock market in the same month of March began a long rise during which stock prices trebled before the crash of December

1921.

Erzberger's exit, almost to the day, therefore marked

the commencement of the great prosperity of

19201921

for which he had

laid the foundation. From the day the boom began, however, its end was already forming. The Reichsbank had already turned on the money pump again. That was what fueled the new boom.

The German money supply doubled again

during the era of steady prices.

With Erzberger safely out of the way,

taxes were reduced and decits increased. By the summer of

1921,

when

price ination at last began to rise again in pursuit of the money ination, the die was assuredly cast. As a postscript, we might record that the mere ruination of Erzberger did not complete reactionary Germany's retribution against him. An unsuc cessful attempt to assassinate him had already been made during his trial. Something more than a year later, on August

26, 1921,

as the inationary

end of the boom impended, Erzberger was successfully assassinated. The execution was administered by members of the terrorist gangs who mul tiplied among Helerich's reactionary wing of Germany, although clearly Helerich himself was not implicated in the murder plotting.

The man

Erzberger who had been intrepid or incautious enough to point a nger in the right direction was thus extinguished.

26

6 Politics The political situation in Germany contributed greatly to its inability to deal with the ination. Germany had suered a Marxist insurrection before the end of the war which was not fully controlled until after bloody ghting in the early months of

1919.

Even after that, governments were constantly

forming and falling, extremist secret groups were busy, rebellions like the reactionary Kapp Putsch in

1920

were frequent, and the country remained

in a state of perpetual political ferment. Out of the war and to some degree the Marxist activity came enormously strengthened labor unions. A rash of liberal labor legislation such as the controversial eight-hour day was enacted. The unions raised wages and cut work. Employers liked to lay much of the blame for the ination on this increase of labor's power, forgetting however that business and not labor proted the more from the ination. The Weimar republic's new constitution was a masterpiece of democratic theory, and in the best democratic tradition the government was hopelessly responsive to its sources of support. A government so plainly a weather- vane to the prevailing winds was ill suited to override the shortsighted self-interest of its power groups and deal sternly with hard realities. The chief supports of the republican government were the Social Democrats or SPD, who were the orthodox labor party, and the liberal intellectuals. Busi ness and capital also had great inuence through their economic strength. When the government tried to evolve adequate tax plans, labor blocked in come or consumption taxes which would weigh upon workers, and business and property blocked taxes which would weigh upon capital. So, very sim ply, no one paid. The government's most incredible step of all was the tax reduction of

1920

in the midst of decits, after the departure of Erzberger

when the die for its fate was being cast. The Social Democrats were the largest single party in Germany at all times, and for that reason if no other must bear some part of the responsi bility for what happened politically. The republic's honored rst president,

27

6 Politics Friedrich Ebert, was a Social Democrat, as were a few of its chancellors. The Social Democrats were undeniably a stalwart and steadfast party, indeed the uninching backbone of Germany after the war.

The Social

Democrats spoke for the overwhelming majority of the German workers. It lies to the credit of the steadfastness of the German workers that the Marxist turmoil utterly failed after the war; the actual murders of the Marxist leaders, Rosa Luxemberg and Karl Liebknecht, though often com pared with the Russian Mensheviks' failure to dispose of Lenin in similar circumstances, were quite superuous because the German workers through the Social Democratic party had already shown that they wanted no part of Marxism. Later on, the Social Democrats were an unimaginative and sometimes block-headed party and furnished comparatively few important leaders in relation to their size. Their worst failing was a dim-sighted ob stinacy against infringing on any of the newly won privileges of labor; as a result, they obstructed bold cures for Germany's ills, but they also were not actively responsible for the most harmful of Germany's policies. Occa sionally, though rarely, they rose above themselves to support the sound policies of an enlightened leader from some other party, such as Stresemann, and this in the end made it possible for Germany to save itself. Most of the political wisdom that was shown in Germany of the ination came from individuals of the several middle-class parties, each of whom had relatively small political backing of his own. Erzberger, of the Center Party, was an example. Gustav Stresemann was preeminently an example; his People's party was generally far more rightist than he was, and included even such leading reactionaries as Hugo Stinnes and Johannes Becker. Any of these good leaders, in order to act, had to piece together a coalition ranging from the Social Democrats all the way to the semi-reactionary parties like the People's, stopping short only of the Communists on the left and the Nationalists and Nazis on the right. By all odds the principal blame for the ination must rest with the right-wing parties and with the industrialists and propertied interests who backed them. Helerich of the Nationalists laid the groundwork with his mismanagement during the war.

Magnates like Hugo Stinnes and Fritz

Thyssen and the entire voice of big business obstructed every eective ef fort to put a stop to the ination, because very simply the ination was good business for them. When Germany at last turned to the prominent industrialist Wilhelm Cuno in November

28

1922,

in the hope of nding suc

cor in a government of businesslike soundness, his impotent administration from then until August

1923, with the inimitable Johannes Becker in charge

of economics, presided inertly over the worst months of the ination. Even in November of

1923,

the last ditch for the German nation, polit

ical paralysis was so pervasive that chancellor Stresemann's only way to shortcut the interminable parliamentary deliberation, which had brought Germany to this pass, and institute the miraculous Rentenmark, was to assume dictatorial power to rule by decree under the emergency provisions of the Weimar constitution. These same extraordinary powers under the constitution were later accused of facilitating Hitler's usurpation of abso lute power, which they did. Indeed, Stresemann's sweeping enabling act of October

1933.

1923

was strikingly similar to Hitler's infamous act of March

Only Stresemann's wise and brief use of the Weimar powers in

1923,

however, saved Germany from an immediate choice between Hitler and Communism. For his pains, Stresemann was turned out of oce as chan cellor less than ten days after the ination had been nally halted by the Rentenmark, and scarcely three months after he had taken over the oce. Stresemann thereafter served brilliantly as foreign minister through most of the remaining years of the Weimar republic, but he never again was chancellor.

29

6 Politics

30

7 The Lessons Throughout the ination, the characteristic of the Reichsmark which was most vitally important and at the same time most securely hidden was the unrealized depreciation in its value. This was the dierence between the relatively small decline in its eective value, which had already been realized through rising prices, and the much larger fall in its intrinsic value which was caused by pouring out ever-increasing numbers of marks as di minishing shares of the more or less constant total value of Germany. The unrealized depreciation of the mark was almost always present and almost always worsening, but it was dicult to detect and practically impossible to measure. The phenomenon of the unrealized depreciation explained the spectacu larly benecial eects of the ripening stages of ination, when new marks could be turned out much faster than their value could fall and could thereby create real wealth out of thin air.

Unrealized and unsuspected

depreciation also accounted for the remarkable complacency of Germans, who were prone to think they were always more or less square with their past scal sins. If they escaped from the war extravagance with endurable price increases, and from the even greater extravagances of the

1920-1921

boom with practically no price increases, they were able to feel safe. They were understandably bewildered when the ination then burst over their heads in an unforeseen enormity and for no apparent reason.

The un

realized depreciation of the mark measured precisely its capacity for an explosive and self-sustained ination which was no longer aected by what the government might do. The capacity to absorb unrealized depreciation was a bit of patient le niency on the part of the respected Reichsmark.

It was always possible

that the unrealized depreciation might never be realized, if the growth in the real value of Germany had ever been allowed to make good the spuri ous value of the mark. Some degree of unrealized depreciation also could have been carried by the mark indenitely. The exact degree is so uncer

31

7 The Lessons tain that, as Dr.

Schacht said, a government nance minister must feel

the danger line with his ngertips. Any degree of unrealized depreciation was of course less safe than none, and once used was no longer available as a reserve against economic reverses. To go still further and exploit the mark to the very limit of its ash point was risky at best, especially when the government ministers were totally unaware that anything like Schacht's ngertip sensitivity was needed. The government's practical ability to make good on the mark, as distinct from its theoretical ability, was undoubtedly limited.

Once begun, the

ination required ever more inationary expansion just to support the old debts. Germany had to run faster and faster to stay ahead of the engulng wave, until it simply could not run any faster. Stopping the ination would have killed the boom, and that seemed excessively unpleasant.

In this

respect, peacetime ination was far more insidious than wartime ination, which produced only war goods to be expended and no boom for the people to become addicted to. Hugo Stinnes in a much-noted speech declared that it was madness to think that a defeated Germany with all its huge burdens could spend more, have more, work less, carry an ascending prosperity, and do it all with mirrors. But Germany seemed quite willing to try. It was theoretically possible for Germany to extricate itself at virtually any time it chose. If any of the inated mark wealth was to be salvaged in the process, Lord Keynes and Dr. Schacht, two wizards of the black art of economics, both happened to agree that the way to do it was to stop the money and debt and to close the gaps with capital taxes designed to soak up some of the excess supplies of money. This incidentally was what Erzberger tried to do in a crude way. Capital taxes made sense, because the brimming coers of capital were where the prots of the ination gravitated; wage and salary earners were already laboring heavily under the ination and had no more capacity to pay taxes. An impartial tax on all capital would clearly have been less destructive than the totally conscatory tax which eventually fell on one part of capital  the savers and lenders. In any case, neither this nor any other means of dismounting from the inationary wave was ever resolutely tried. Though it was always possible to dismount, it was never possible to dismount painlessly.

Every day that passed, appeasing the inationary

dragon with more ination, increased the assured severity of the inevitable medicine.

32

So long as the Siren-like lure of the easy wealth continued, it

was impossible to persuade enough of the nation that titanic measures of austerity and self-denial were necessary. When the Siren's song stopped, the crash had already begun and it was too late. In nal analysis, there is more dierence of expert opinion than one might expect about whether the ination was good or bad. Its horrors while it lasted and the permanent harm to millions of individuals which it left in its wake might appear to speak for themselves. From a transoceanic distance, detached economists like the American Professor Frank Graham were able to weigh up the pluses and minuses and discover the cold-blooded conclu sion that the ination may actually have been a good thing for Germany as a whole from a strictly material standpoint. Germany as a whole suered no net loss in the ination; no real wealth was destroyed; the economic ma chine was still intact, ready to go again rather quickly; for every loser there was a gainer. The great middle class and all the savers and lenders who lost all their wealth merely saw it transferred to debtors and to the gov ernment for the rest of the people, not destroyed. Production increased, employment increased.

Conceivably the ination may have helped Ger

many recover from the war and come out from under its load of liabilities more lightly than it could have done in other ways. It may even have been a net gain to the productivity of Germany in a material sense to wipe out all the pensioners and herd them back into the labor force, as Professor Graham notes. If so, the Germans who lost might be excused for nding no comfort in knowing all of this. In the end, Germany perhaps did not get o altogether so lightly from the ination, nor did the world.

The later agony of Germany and the

world, personied in Hitler, was deeply rooted in the inationary crash. It was no mere coincidence that Hitler's rst Putsch occurred in the last and worst month of the ination, and that he was in total eclipse later when economic conditions in Germany improved. When still another economic crash struck Germany in the

1930's, Hitler rode into power not by coup but

by election. His most solid supports at that later date were an implacable middle class, the same who had paid the piper for all of Germany in

1923

and who suered grievously again when the Depression came. Middle class parties which had polled twelve million votes in peared into the Nazi column in

1920

had virtually disap

1932, and Hitler required only a plurality of

fourteen million votes in that year to win. Writing in his generally astute analysis of the German ination in

1930,

barely two years before the onset

33

7 The Lessons of the Hitler nightmare, Professor Graham was able to make this marvel of miscalculation of the psychological scars of the ination: With all these reservations taken into account, however, it cannot but be asserted that, considering only the material as pects of the matter, the Germans, as a nation, proted rather than lost through the collapse of their currency. The adverse eects on the national psychology were no doubt of import, but they cannot be measured, and these eects will perhaps more quickly disappear than is ordinarily supposed.

(Italics added)

It is of course impossible to prove just how much the millions of decisions by individual Germans to vote for a stronger government in the Hitler elec tion of

1932

were inuenced by lingering bitterness against the ination's

injustice. What is clear is that the ination was less than ten years past, which is a short memory span for an extreme injustice compounded by even more recent woes. Misgoverning the country perpetually at the expense of its quietest and steadiest class cannot be disregarded as possibly the best explanation why the plurality of Germans at last turned to Hitler.

The

wages of economic charlatanry proved to be rather high and not merely economic.

34

ACT ONE: The Rise of the Great American Ination

35

8 The War For the time being, forget completely one obvious and important fact about the American ination. about

70

That fact is that the American dollar lost only

percent of its value from

1939

to

1973.

Prices were not quite

3.5

times as high at the end of that time as at the beginning. In thirty-four years, that was a smaller loss than the Reichsmark suered in a single year after the ination steamroller began to roll, or in just two or three average days as the ination approached its nal crash. By comparison, a loss of only

70

percent of value in three decades was not too bad. The American

ination was therefore obviously much dierent from the German ination. For now, forget that. Postpone until the end of the book deciding whether they were so fundamentally dierent that nothing could be learned from the German ination. It is not necessary to decide now, and deciding now will only cloud your judgment. The United States ination welled up from much the same sort of original fountainhead as the German ination, namely a war. In

1939

the prepara

tions for World War II were already beginning, and the American economic experience of that war when it came was a standard wartime experience. As with the German experience of the rst war, three aspects characterize it: accumulating war debt, money expansion, and comparatively mild price ination. In the seven years' titanic struggle of the second war, the Federal debt of the United States increased to the level of $269 billion, which was about one-fourth greater than the annual gross product of the nation at the time. The gross product of the nation had itself increased by about half from its prewar level. Monetary expansion in the same seven years was even more startling. The American money supply grew by out in

1947.

3.5

times before it topped

The performance of prices during the war, on the other hand,

was remarkably docile. In June of

1946,

when the war had been over for

almost a year, prices had increased by less than half from the beginning of

1939.

For a seven-year period embracing the greatest war eort in history,

37

8 The War that was fairly good. It was also fairly typical of big wars. German price ination during actual hostilities in World War I had been almost equally mild. There are several probable explanations for these low rates of price ina tion during actual warfare. One is price controls; the United States had a rigorous and comprehensive system of price controls during World War II. Another is the absorption of money into the nancing of war debt itself, rather than the purchase of goods. Still another is the tendency of people during big wars to hold money for safety's sake rather than to spend it on anything. This causes what is known as abnormally low money velocity, and it reduces the pressure on prices. By war's end, however, a much larger ination was already built and ready, waiting to happen. The latent depreciation of the dollar was much greater than the actual depreciation had yet been.

Monetary expansion

during the war had already established an equilibrium price level much higher than the actual level that prices had yet reached. As it turned out, the real value of the dollar was something like two-thirds of its apparent value at the end of the war. It was an absolute certainty that prices would proceed quickly upward toward the higher equilibrium as soon as the con trols were released, even if the government did no more inating. Under the circumstances, there was nothing for the government properly to do but to stop inating, release the controls, let the ination happen, and wait. To its great credit, that is exactly what the government did do. The ination burst out, ran its course and, at the preordained level, stopped. The government's excellent management after the war seems to have been more inadvertent than deliberate. It is truer to say that price controls fell apart than that they were removed.

The Democratic administration

fought manfully against removal of the controls they so dearly loved. Harry S. Truman, who was president at the time, pleaded with Congress to extend price controls for at least another year after June

30, 1946.

Congress was

bent on putting an end to the controls, however, and sent him a bill so weak that he vetoed it.

In the single month of July, before another bill could

be readied, wholesale prices rose by more than ten percent.

Eventually

another bill did provide for temporary continuation of controls, but they proved unworkable and nally broke down before the end of

1946.

In the

two years following the breach of the price control dam, prices increased by about as much as they had done during the entire war, although the

38

government added no new debt or money. In the end, prices were twice as high as they had been in

1939,

and at that level they stabilized.

The explosive growth of the money supply during the war began to decel erate as soon as hostilities ended. For two full years while prices galloped upward, the money supply increased by less than prices did. As long as this condition obtained, the nation could condently wait for the result. In due time the ination would stop and did stop. from

1947 to 1950,

For three full years

the money supply remained essentially static. This was

the longest period of monetary stability in the United States after

1928.

Prices too were steady as long as this condition prevailed. The nation un derwent a recession in

1949

as a result of the monetary stringency, but

fortunately the unlled desires of the nation for civilian goods bolstered business reasonably well while the anti-ination medicine was being taken. President Truman's administration displayed little understanding of what was happening or of its own good management. In his June

1946 veto mes

sage pleading for stronger price controls for another year, President Truman was able to say unabashedly, "For the last ve years we have proved that ination can be prevented [by controls]." This of course was wholly wrong. At that point, the big ination to come had already been built. Nothing that the government did after the war was responsible for the price ination of the next two years, and nothing that the government could have done could permanently prevent it from happening. By November of

1947,

after a year's severe ination, President Truman

was back again with a panicky plea to a joint session of Congress for the whole array of new price controls, rent controls, credit controls, and ra tioning. Reviewing the disheartening course of the ination since the pre ceding year, he asked querulously, "Where will it end?" Thanks to balanced budgets and the continued quiescence of the money supply, the ination was in fact already within a few months of ending. Congress had become Republican in the previous autumn's elections and gave the president sub stantially none of his controls. The ination nevertheless ended within a few months in early

1948,

right on schedule.

The Federal Reserve System, which like the Reichsbank in Germany was the guardian of the money supply, seems to have been as uncomprehending as the Truman administration was. In

1947, it too was calling for new pow

ers and controls. The remarkable stability of the money supply throughout these years occurred without the conscious volition of the Federal Reserve.

39

8 The War In other words, it was pure luck.

In those days, the monetary policy of

the Federal Reserve was dominated by its duty to control interest rates on government obligations. If interest rates tended to rise, the Federal Reserve issued money to stop their rising, but not otherwise. It happened that in terest rates did not tend to rise during the postwar years, partly because of budget surpluses and partly because of general fears of depression, and for this totally fortuitous reason the money supply remained steady and the price ination was allowed to end. The American experience of World War II had some similarities to Ger many's of the previous war, and some dierences. The war debt burdens were quite comparable in the two cases. The American war debt of $269 billion was about a quarter more than the annual national product; the German war debt of

153

billion marks was about a half more than the an

nual national product. Where Germany's performance was dismally worse was in its ination of its money supply by American monetary ination of only

3.5

25

times, compared with the

times. Germany's price ination

after the war was just that much worse than America's was. Germany's prices were multiplied by seventeen times by the time they stabilized; Amer ica's, by only two times. The ratios of price increase to money increase were virtually identical in the two cases, prices having increased by about

60 per

cent as much as money supply, even though the magnitudes of expansion of both kinds in the two cases were radically dierent. The much more extreme price ination in Germany had the perverse eect of leaving Germany somewhat better o after the war with respect to its war debt. As Lord Keynes observed at the time, nations are subject to a practical limit of how much debt their taxpayers will bear. Any nation's debt which exceeds the limit must somehow reduce the debt to come within the limit. The only three ways to reduce the debt are to repudiate it, to assess capital levies and pay it, or to inate and dilute it. the way which is invariably used. acute that the real burden of its ve-sixths to a mere

25

or

30

153

Ination is

Germany's postwar ination was so billion marks of war debt was cut by

percent of its annual product.

Even with

the continuous addition of new government debt during the ensuing boom, the real value of Germany's national debt never again rose above about

40

percent of annual product. By contrast, the postwar ination of the United States was so much less acute that the value of its war debt was still fully

40

90

percent of annual

product in

1950.

As late as

1968,

more than twenty years after the war,

the war debt of the United States was still worth

30

percent of annual

product, a level which Germany had reduced to within two years. Total Federal debt of the United States in

1968

approximated the

40

percent

gure which appeared to be Germany's practical maximum. The United States and Germany thus each reached a point of stability after the respective wars at which their wartime inations had been ef fectively liquidated.

The burdens of their past conduct were reduced to

manageable proportions, and they could move in any direction they chose. The inadvertent success of the government in the United States compared with the good work of Matthias Erzberger in Germany. Germany's ina tion was enough worse so that Germany was better o, but Germany also had many other problems like reconstruction, revolution, and reparation which the United States did not have. Germany's stability was therefore more frail and transitory. The economic experience of the United States was a standard wartime experience; it was not the only way a war could be nanced, but it was the way virtually all wars are nanced. After the war, the economic system, the currency, and above all the enormous Federal debt and corresponding paper wealth of the United States were intact. This was fortunate in one way, unfortunate in another. A nation is in a stronger position to rebuild its life on a healthy base if all the overblown old money and credits have been written o, although this is hard on those who lose their values. A quick and clean ination, which destroys paper wealth like an amputation, is often less vicious than a suppressed and protracted ination.

But bankruptcy

reorganizations like this are what happen to losers of wars, not to winners.

41

8 The War

42

9 Grappling with Stability The United States became embroiled in another smaller war in Korea in

1950.

This was a minor war by any standard and especially by comparison

with World War II. The Federal budget did not even run a decit ghting the Korean War.

Nevertheless, the wartime ination which need never

occur was allowed to occur again. of

1953, 13

1949

until the end

when stability was regained, the American money supply was

permitted to expand by about

From the end of

16

percent. Prices dutifully increased likewise by

percent.

The Korean War ination was a most unusual sort of ination. the day in June

From

1950 when the North Koreans attacked the South Koreans

to start the war, wholesale prices in the United States ascended smartly. Buyers and sellers, with the memory of World War II and its controls and ination fresh in their minds, were quick to raise prices jointly. a mere eight months wholesale prices had risen

18.6

Within

percent above

1949,

while the money supply had not yet expanded by a third as much. This ination was a psychological one, not a monetary one. The equilibrium level of prices was actually lower than actual prices were, so that there was an unrealized appreciation of the dollar. If the government had done nothing more, the trend of prices would have had to be constantly downward. The psychological expectations of ination would have been disappointed, and prices would have subsided to near their original levels. The trend of prices was in fact downward from the initial peak, but the government meanwhile inated the money supply to catch up with the prices. This money expansion validated the price ination and made good on the expectations. The eect was to stabilize prices at the higher level rather than to let them fall back.

The administration, still Democratic

under President Truman, also joyfully clapped on price controls again, but they were superuous and accomplished nothing good or bad. Since there was no ready-built ination, no unrealized depreciation of the dollar, lit erally nothing happened to prices when President Eisenhower unceremoni

43

9 Grappling with Stability ously terminated the controls a month after his inauguration. The Federal Reserves management of the money supply in this Korean phase was again rather insensitive, and luck was not so good as during the three years before the war. At the commencement of the war interest rates rose steeply for much the same reasons that prices did  psychological reasons  and this meant automatically that the Federal Reserve must inate the money supply according to its duty to support the prices of government bonds.

The resulting rate of money ination was much less

fast than that of prices, but it was nevertheless substantial. In short order, the Federal Reserve and the Treasury were forced to reach their momentous Accord of

1951,

which relieved the Federal Reserve of the formal duty to

support government bond prices.

The Federal Reserve's ination of the

money supply did not quickly end, indeed it continued largely unabated for two more years, but at least one irrelevant criterion was theoretically removed from its policy making. The month following the Accord of

1951

also brought to the Federal

Reserve a new chairman, William McChesney Martin, who remained its helmsman and its spiritual patriarch for nineteen years through both the prickly stability of President Eisenhower and the orgiastic ination of Pres idents Kennedy and Johnson. A change of political command now occurred. Dwight D. Eisenhower, formerly supreme commander of all the allied armed forces in Europe in World War II, won the presidential election in November of

1952.

He was

a Republican and his administration leaned toward conservative business principles, but the change from the Democrats of President Truman was not so great in the realm of economic management as might be supposed. The Truman administration, for example, had had no net budget decit for its total span of years, leaving aside the scal year

1946

which wound up

the big war expenditure. President Eisenhower was not quite as success ful as President Truman in maintaining budget balance, mainly because of decits incurred in ghting the recession of

1958,

but his eorts were

similar. President Eisenhower's nancial administration picked up where President Truman had been forced to leave o at the outbreak of the Ko rean War, confronting problems of stability and prosperity which President Truman had then only begun to face. The years of President Eisenhower were the least inationary of any period of similar length in the United States since

44

1914.

The money supply

averaged an increase of only a bit over

1

percent per year, and prices did

about the same. This policy persisted after President Eisenhower left oce,

1953

so that the monetary stability embraced the nine years from

1962.

to

One of the results was an extraordinary period of seven years (1958 through

1964) in which wholesale prices never varied by as much as 1 percent above or below their mean. The years of the Eisenhower administration and after were not years of uniform stability, however, nor of uniformly satisfactory prosperity.

The

same nine years of average stability saw serious and recurrent recessions. From the time when President Eisenhower took oce at the beginning of

1953,

the nation's economic condition passed through a series of gradually

worsening monetary oscillations, every one of them followed by alternating boom and recession. The government rst tried a non-inationary money growth of less than i percent per year in

1953 and 1954.

That was too tight

and produced a recession.

The government obligingly next tried a more

liberal money expansion of

3.9

percent per year from

1954

through

1956,

which produced a very pleasant boom followed by an ination. After that the government expanded and contracted money with increasing vigor and

1957, inated in 1958-59, 1959-60, inated again in 1961, and contracted again in 1962.

on a shorter and shorter cycle; it contracted in contracted in

Every burst of monetary ination was followed by a stock market rise and a boom prosperity; every contraction, by a stock market fall and a recession. Whenever the expansions and contractions were allowed to persist long enough, they were followed eventually by price ination or stabilization, respectively. But prices were always slowest to follow, so that they stopped responding to the shorter cycles and remained steady after

1958.

Stock

market boom and bust, prosperity and recession, employment and unem ployment, being more sensitive, never failed to follow the monetary lead. A recession and rising unemployment in late

1960,

following the monetary

contraction which had ended some months earlier, helped defeat Richard Nixon, Republican successor to President Eisenhower, in the presidential election of November

1960.

At the time, a monetary expansion was already

well under way, but the usual economic upturn did not develop until early the next year. The Eisenhower years thus showed an average line of overall stability in both money and prices, but this stable line represented a median between fairly sharp swings upward and downward.

These years also showed no

45

9 Grappling with Stability more than partial success at grappling with the problems of stability. The booms were fairly good times, but no better than they ought to be. The recessions were worse than they should be. Price ination followed mon etary expansion and prosperity like a somewhat distant shadow, and the government consistently failed to maintain a reasonably satisfactory level of prosperity with a monetary policy tight enough to prevent ination. The

3.9

percent rate of money growth of

1954

to

1956

which started it all, al

though low by standards of the next decade, was nevertheless enough to

1956 and therefore was obviously not tight enough. On the other hand, the monetary non-growth of 1953 and 1954 was enough to produce the recession of 1954 and therefore was obviously too tight. There start the ination of

seemed to be no golden mean between the two kinds of policy, which were themselves not at all extreme. The Eisenhower administration was a time of mixed returns. called it a time of stagnation.

Critics

Champions called it a time of stability

and a leaking o of inationary pressures. Undoubtedly there was room for improvement at its close. A simple continuation of the policies of the Eisenhower administration into later years, as might possibly have followed if Richard Nixon had been elected in

1960,

would not have been the very

best possible course for the nation, but even that course would have been innitely preferable to what actually did occur.

The United States had

consolidated its economic base and was stronger than at any time before or since, ready to move in any promising direction that a shrewd leader might have chosen.

46

10 The Great Prosperity of 1962-1968 The year

1960

marked the continental divide in the postwar economic his

tory of the United States. If there turns out to have been a day of decision that corresponded to the fall of Matthias Erzberger in Germany on March

12, 1920,

it must surely be November

8, 1960,

which was the Election

Day on which former senator John F. Kennedy was elected president of the United States.

In both cases these days of judgment occurred even

before the great booms of the two countries began. John Kennedy was a Democrat who owed his extremely narrow victory in the election to eco nomic problems of the previous administration. He was a very young man as presidents go, and he was vigorous and active as young men go.

He

gained oce on the famous vow to "get the country moving again." He was a wealthy young heir who had neither compiled wealth of his own nor ever done any productive work, but had spent virtually his entire adult life serving in one or the other house of Congress.

His own intellectual

credentials were indierent at best, in spite of a Harvard education, but he had an extraordinary weakness for intellectuals. He surrounded himself with academic theorists as advisers, especially economists, and he submit ted to their guidance as no political government had submitted before. So armed, he addressed himself to getting the country moving again. And the prescription that his doctors ordered was two-hundred-proof ination. The band of academic economists who accompanied President Kennedy into power represented the nal accession to the wheelhouse of what was commonly called the "New Economics." These economics had been ger minating in the universities ever since the publication in

1936

of John

Maynard Keynes' General Theory. They thus constituted Keynesian eco nomics to a degree, but they transcended anything that Keynes himself had ever written. In brief and in part, they stood for a thriving economy and full employment to be achieved by actively sought government decits,

47

10 Prosperity of 1962-1968 plentiful new money and credit at low interest rates, liberal government spending, and extreme emphasis on capital investment. The United States had made a polite gesture toward Lord Keynes by abstractly embracing the full employment principle in the Employment Act of

1946,

but neither

the Truman administration of that time nor the Eisenhower administration bore the faintest resemblance to the New Economics. The professors of the New Economics were left to simmer in their cloisters and to await their day. Their day came after the inauguration of President Kennedy in

1961.

The man who was chosen to serve as economic mastermind to the Kennedy administration was Walter W. Heller, an economics professor from Min nesota who became chairman of the Council of Economic Advisers.

In

fairness to President Kennedy, it has been observed that he did not re spond with alacrity to the advice of his economic confessors, but it took Mr. Heller nearly two years to "educate" his somewhat backward pupil, the president. In fairness to Mr. Heller, it has also been observed that ve out of any six American economists chosen at random would have advo cated the same policies that he and his fellow advisers did. The American ination had no towering personal gure to shape it as Helerich had done in Germany; Professor Heller was but a spokesman for virtually the entire economic priesthood which must bear the blame if any blame there be. The Kennedy administration was slow to make itself felt economically. Fully a year and a half passed, from the beginning of the administration in

1961

through most of

1962,

during which time essentially the Eisenhower

economics persisted complete with monetary expansion and contraction, stock market rises and falls, and less than satisfactory employment. Partly this delay was due to the need for Professor Heller to educate the presi dent in modern economics, and partly it was due to President Kennedy's preoccupation with non-economic matters such as his saber-rattling over the construction of the Berlin wall by East Germany, his involvement with the Bay of Pigs invasion of Cuba, and his showdown with Russia over the Cuban missile crisis. The commencement of both the great ination and the great boom can be traced to the month of October of

1962.

In that month began an unremit

ting monetary expansion which extended, with only brief interruptions, through the next eleven years with no end coming into view. It was the longest and steepest monetary ination in the United States since World War II, almost twice as fast as that of the

48

1956

boom, considerably faster

than and three times as protracted as that of the Korean War. The mon

4.6 percent per year for the rst 7.2 percent per year for 27 months more (January 1967 through April 1969). The total money ination over the seven years was about 38 percent. Up to 1969, the ination was inter rupted only by the nine-month period of no expansion in 1966, which was etary ination proceeded at the rate of

43

months (through April

1966)

and

accompanied by stock market collapse and economic recession but precious little eect on price ination. At the close of this time, monetary ination was proceeding faster than ever. The commencement of the ination in October of

1962

happened to co

incide with the enactment in that month of the Revenue Act of

1962,

one

of the rst solid accomplishments of the New Economics under President Kennedy. The principal feature of that tax law was the unfortunate invest ment credit, a tax subsidy to business equal to

7

percent of expenditures

on new capital assets such as machine tools, computers, oce desks, and airplanes.

The philosophy behind this law was the orthodox Keynesian

xation on business investment as the determinant of economic prosperity. Several months earlier, the Treasury Department had greatly liberalized tax depreciation allowances to the same end. These measures led to the exaggerated investment boom of the Already in

1962

1960's

decade.

the economic advisers were in pursuit of bigger game.

The big tax cut in the midst of decits in

1964

which was to be the star in

the diadem of the New Economics was already in gestation in

1962

thanks

to the unagging eorts of Professor Heller and his associates. This tax cut was of course the blood brother to the inexplicable German tax cut amid decits in

1920.

President Kennedy was assassinated in November of

1963.

He was suc

ceeded by his personally chosen vice-president, former senator Lyndon Johnson, a lifelong politician from Texas.

Mr.

Johnson was in turn re-

elected by a landslide in the following year against the challenge of a Re publican conservative, Senator Barry Goldwater. President Johnson, who had long been majority leader of the Senate, was a top sergeant type who knew well how to do what was demanded, but apparently not how to de cide what to demand. Antithetical though he was to President Kennedy in virtually every way, he nevertheless changed nothing upon his succes sion except to outdo his predecessor. He retained the Kennedy crowd and pursued the Kennedy ideas, for lack of any better ideas of his own. One

49

10 Prosperity of 1962-1968 of the better virtues of President Kennedy's administration had been its very inability to accomplish its own objectives; one of President Johnson's more serious aws, his unfortunate ability to accomplish what was better not accomplished. A boom gathered steam from

1962

onward.

There can be no denying

that there was apparent prosperity; the excellent year of

1956

paled beside

it. The government succeeded in deliberately increasing its budget decits to the vicinity of $7 billion per year, surmounting even the growing tax revenues which the boom yielded. The big tax cut, when it came in

1964,

eased the increasingly dicult task of expanding the budget decits. The stock market had been dutifully soaring ever since the commencement of the monetary ination in

1962.

The exultant New Economists proclaimed

that they could "ne tune" the prosperity like a television set, a claim which they later learned to rue. The big tax cut and the intentional decits of the Kennedy and John son administrations received most of the economic attention, but the less noticed behavior of the Federal Reserve Board was even more remarkable. The Federal Reserve inated obligingly throughout the boom and long af ter. This was a Federal Reserve in which no dramatic changes of personality had occurred, a Federal Reserve which was still under the chairmanship of the estimable William McC. Martin who had been closely associated with the far more restrictive Eisenhower economics.

It is true that President

Kennedy made menacing omens when Chairman Martin dared to speak as if the Federal Reserve would not underwrite the decits, but the fact is that the Federal Reserve accommodated itself to the economics of the government in power. This it should and must do. There cannot be two or more captains steering a ship, no matter how dubious the judgment of the chosen captain may be. Prices displayed considerable inertia during the rst several years of the boom, but at last they began to stir. Slowly at rst and then faster, they ascended.

The abortive period of tight money imposed by the Federal

Reserve in

1966

sought to stop the price ination. It throttled the boom

for the moment but had little success with prices. The rate of price ination continued to gain speed, until by

1969 it was approximating the average rate

of monetary ination (5 percent) over the seven years of its life to that date. Even while rising smartly, however, prices lagged ever farther behind the cumulative level of the monetary ination. Wholesale prices, for example,

50

11 percent higher in April 1969 than at the stability level of 1962, while money supply was 38 percent larger and increasing

were still only September

faster. As we shall see later, the dierence between these two percentages represented the unrealized ination and was of the utmost importance to every aspect of the ination. This is where the story of the great prosperity leaves o. There was much more to it than this, of course. In

1965

President Johnson precipitated the

nation into deep involvement in another war, which had been gradually begun by President Kennedy, this one in Vietnam which was a remote and unimportant part of Southeast Asia. The war, an exceedingly unpopular one, threatened to tear the fabric of American society to tatters with its protests, its demonstrations, and its riots. The deepening involvement in this war happened to coincide with the time when prices began to rise in response to the inationary boom, and for this reason the war was widely blamed, though unjustly, for the ination. In the presidential election of November

1968, President Johnson did not even dare to run again.

Richard

Nixon, who had just missed gaining power over a stable situation in

1960,

had the extreme misfortune of being elected to inherit this shambles. The year

1968

ushered out the great prosperity of the decade, leaving the price

of it still mostly unpaid.

51

10 Prosperity of 1962-1968

52

11 The Inationary Syndrome The immense outpouring of inated money by the American government from

1962

through

1968

did apparently have its intended eect, which

was to produce prosperity.

The Democratic government did succeed in

getting the country going again, in a way. increased by an astounding $360 billion, or with only

1960.

The gross national product

7

percent per year, compared

4.8 percent per year in the dicult Eisenhower years from 1955 to

Unemployment constantly decreased. The stock market was almost

constantly rising for more than six years. It was apparent prosperity such as the nation had seldom seen. The immense outpouring of German Reichsmarks in

1920

and

1921

had

apparently succeeded in procuring prosperity too. Money ination of these magnitudes almost never fails to achieve dazzling prosperities of this order in the beginning.

That is what ination has been all about for lo these

thousands of years. Given the extraordinarily solid base of stability which had been painstakingly laid in the United States by President Eisenhower, or in Germany by the reforms of Matthias Erzberger, any simpleton could have made a prosperity by the ancient and honored elixir of ination with out any bad eects to show for years to come. This is what the government did. The great American prosperity of the

1960's

was built on nothing but

the money ination. Clearly the managers of the American ination succeeded far better than the Germans did. They inated far less rapidly and in a more controlled manner, and by so doing they sustained the inationary cycle much longer near its delightful peak. A few percentage points of money ination pro duced almost as great a prosperity but allowed the inevitable retribution to be much longer postponed and initially much less violent.

That does

not alter the basically identical shapes of the inationary cycles. Everyone loves an early ination. ination are all good.

The eects at the beginning of an

There is steepened money expansion, rising gov

ernment spending, increased government budget decits, booming stock

53

11 The Inationary Syndrome markets, and spectacular general prosperity, all in the midst of temporar ily stable prices. Everyone benets, and no one pays. That is the early part of the cycle. In the later ination, on the other hand, the eects are all bad. The government may steadily increase the money ination in order to stave o the later eects, but the later eects patiently wait.

In the

terminal ination, there is faltering prosperity, tightness of money, falling stock markets, rising taxes, still larger government decits, and still roaring money expansion, now accompanied by soaring prices and ineectiveness of all traditional remedies. Everyone pays and no one benets. That is the full cycle of every ination. The United States by

1968

had not yet seen

anything but the upslope of the cycle. On closer examination, that awesome apparent prosperity up to

1968

that was to be dearly paid for in later years begins to look as fundamentally illusory as the German prosperity had proved to be. An

11 percent growth 16 percent just

was necessary just to keep up with population, and another to keep up with prices.

The actual growth considerably exceeded those

requirements, but if ination is too much money, inationary prosperity was too much prosperity. No amount of prosperity is truly too much if it is rmly founded, of course, but inationary prosperity is not. Inationary prosperity is a balloon rising on hot air, quickly cooling.

It rests on the

creation of paper wealth faster than its value can fall. Some citizens stand in the way of large shares of the paper ows, and they benet.

Larger

numbers of citizens do not benet, but they do later pay. There were something like

27

million production workers in the United

States who were doing all the basic productive work of the nation. These were the production workers in farming, mining, construction, manufactur ing, transportation, communications, and utilities.

Their total numbers

1968 as they had been in 1960. They were 13 percent of the population in 1968, and substan

were almost exactly the same in a steadily diminishing

tially less than half the total work force, but they still produced most of what the entire nation lived on. As had been true in Germany, the ina tionary binge was someone else's party and not the workers'.

The gains

in real earnings secured by production workers in private industry during the inationary boom can only be described as paltry. From

1960

to

1968,

the average hourly earnings of production workers, discounted for price in ation, increased by only the apparent growth,

54

3.7

1.9

percent per year. That was scarcely half of

percent per year, of overall personal income per

capita, also expressed in constant dollars. In other words, production work ers received far less than their proportional share of the inationary pie, and this was true of every major category of production workers including even those in the construction industry, where wage increases were thought to be notoriously excessive. By contrast, the real earnings of production workers throughout the decade of the hower years from

1955

to

1960,

1950's, and even in the dicult Eisen

improved substantially faster than overall

national income and faster even than they did in the later inationary boom. from

3.1 percent per year 1955 to 1960. The times

Their real earnings increased an average of

1950

to

1960

and

2.0

percent per year from

were not apparently as lush, but their shares were that much better. All of these comparisons worsened still further after

1968.

These are surely the

most damning of all the statistics of the inationary false prosperity. There is something deeply amiss about any inationary boom like this one which excludes the nation's most numerous and useful class from any share in its spoils. In this respect most inationary booms are alike, and the German and American inations were quite similar. Strangely enough, while workers did poorly in the inationary boom, cap italists in the most fundamentally useful industries fared no better. Prot margins were lower in

1968, a boom year, than in 1960, a recession year, in

many of the largest and most basic industries including agriculture, min ing, transportation, communications, utilities, steel and primary metals, automobiles, chemicals, petroleum, paper, and others. Prot margins, like workers' earnings, grew still worse after

1968.

The rates of price ination

in these kinds of industries had also been very modest up to

1968

and

thereafter, compared with much faster rates of ination elsewhere in the economy. For example, the weighted average price ination from

1968

was only about

6

1960

to

percent in the basically productive half of the econ

omy consisting of farming, mining, manufacturing, transportation, commu nications, and utilities, while it was

27

percent in the other half of the

economy. There was obviously a connection between the inability of these industries to share in the price ination and the inability of their workers and industrialists to share in the spoils of the boom. If all the production workers fared worse in the inationary prosperity, and the most important of the industrialists also fared worse, where then did all the rich fruits of the ination go? It is an obvious question. The answer must be: into the coers of the speculators, the conglomerators,

55

11 The Inationary Syndrome the fringe activities, and the distributees of the government's largesse. It was all very much the same as it had been in Germany. Stock market speculation, which adds nothing to the wealth of any na tion, is the inationary activity preeminent, and it was the craze of America in the

1960's

as it had been of Germany in

1921.

A buoyantly rising stock

market marks the opening stages of every monetary ination. A sharply rising stock market proves to be an unfailing indicator of monetary ination happening now, price ination coming later, and a cheap boom probably occurring in the meantime.

The stock market boom like the prosperity

is founded on nothing but the ination, and it collapses whenever the in ation stops either temporarily or permanently. American investment in the

1960's,

with its instant fortunes, its swamping volumes of turnover,

and its absurdly high prices for incredibly useless ventures, underwent a species of insanity that was quite typical of inationary booms. In

1968,

the last year of full bloom of the inationary prosperity, the volume of trading on registered stock exchanges alone was $200 billion, or more than four times what it had been in

1960.

The income of the securities industry

increased from $1.2 billion to $4 billion. The exchanges were compelled by the overwhelming volume of trading to close for part of the week, as the German Bourse had done in

1921.

Capital gains of individuals reached $36

billion, more than three times the levels prior to

1962,

and more than the

income generated by the entire American gas and electric utility industry and agricultural industry combined. John Maynard Keynes leveled the classic broadside at the American penchant for stock market speculation, even in normal times: "In one of the greatest investment markets in the world, namely, New York, the inuence of speculation . . . is enormous. Even outside the eld of nance, Americans are apt to be unduly interested in discovering what average opinion believes average opinion to be; and this national weakness nds its nemesis in the stock market . . . " ...

speculators may do no harm as bubbles on a steady stream of

enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation." Chronic ination by the government, which came in the train of Keynes himself, enormously amplied the speculative bubble he criticized. Stock market speculation had its customary companions, such as the conglomeration of industries.

56

Germany had Hugo Stinnes and his kind,

and America had its own well-known names among the conglomerators. In the peak year of

1968,

conglomerate mergers sucked up enterprises having

$11 billion of assets, ten times the conglomerate mergers of

1960.

New

investment in stock market issues went into "hot stocks," which were often marginal activities that had little or no productive justication for being. Productive industries changed their names pell-mell to names which de scribed nothing, perhaps to conceal the embarrassing fact that they pro duced anything. The nation's keenest business minds devoted themselves to dealing and disdained production, as they had similarly done in Ger many: ...

production is abandoned in favor of mere business ac

tivity, and such production as is carried on is conducted by entrepreneurs of less average ability than were prots are pos sible only through skillful management. The managerial genius of the nation was channeled into paper empire build ing, and the empire builders who contributed nothing of their own literally bought and sold the creators and managers of real-life businesses. There was this statement of the inationary lunacy, which might well serve as an epitaph to the great American boom: Up to now the idea was to make money only with goods or machinery or something else.

But more people are realizing

that there is a way to make money with money and save the trip in between. Legions of Americans  investors, conglomerators, brokers, advisers, lawyers, accountants, analysts, clerks, programmers, bureaucrats, and so forth  served the business of making money with money and creating absolutely nothing even as a byproduct. By

1970,

after just a little curtailment of the

money ination, the stock market had collapsed, conglomerates and new issues and hot stocks were a thing of the past, and all the legions that had been caught up in the frenzy were a sick lot indeed. Another peculiarly inationary obsession is capital investment. Capital investment means the building of new means of production, such as facto ries and machines. Capital investment is the heart and soul of capitalist industry, so that it cannot be said that capital investment adds nothing to the wealth of the nation. Nevertheless, capital investment too suers from

57

11 The Inationary Syndrome a diseased and useless overgrowth in an ination. The German passion for plowing back inated prots into producing more means of production was so acute that every observer, of the German ination dwelt on it. One said, In the acutest phase of the ination Germany oered the grotesque, and at the same time, tragic, spectacle of a people which, rather than produce food, clothes, shoes and milk for its own babies, was exhausting its energies in the manufacture of machines or the building of factories. After the German ination was over, much of the new investment was found to be useless and was demolished. In America, the capital investment boom was scarcely less pronounced. As it happened, the New Economics of the government had a special love for indiscriminate investment and provided an investment tax credit to help ex aggerate a tendency that would have been strong even without help. More than ten percent of the apparent growth of the American national product from

1960

to

1968,

or $37 billion, represented an increased rate of pro

duction of industrial and commercial buildings and producers' equipment. On the other hand, the construction of housing for the people underwent an absolute decline throughout the apparent prosperity. The real value of residential construction in constant dollars had actually moved downward ever since

1955.

Busying itself with building superuous factories and of

ce buildings, America could not house itself. The phenomenon was the same in the briefer German experience. The true character of America's investment boom, valuable or valueless, could not be clearly seen until after the ination was over. What was clear, however, was that capital invest ment can be valueless, bad capital investment is total waste, and the strong tendency of capital investment in an ination is to be misdirected and to exceed all valid requirements. Still another pronounced tendency of an inationary boom is to channel its growth into fringe activities, which means activities that constitute the overhead of society and do not directly generate any well-being for its members. Germany had this tendency acutely, and the United States did too. Ination's most prominent characteristic is feverish hyperactivity, and generally it is indiscriminate activity at forced draft for its own sake and without any considered connection to a useful purpose.

Ination has no

tendency to stimulate productive activity most, but quite the opposite.

58

In the United States from

1960

to

1968,

even while the total number

of productive workers in all the fundamentally useful industries remained constant at

27

million,

12

million more workers found some other kind

of new place on the national payroll.

There were over a million more

non-production workers in the productive industries; a million more in military service;

3.5

million more government employees;

employees in wholesale and retail trade; and

3.9

2.7

million more

million more in banking,

securities trading, nancial services, and other miscellaneous services. Pa perwork and oce workers proliferated, as they did in Germany. The Xerox machine and the IBM machine, both paperwork machines, were the twin monuments of the decade.

Bank buildings and oce buildings were the

most conspicuous form of construction. The oce equipment industry was the most glamorous of industries. A prodigious apparent growth from

1960

to

1968,

or

36

1131

billion of the nation's

percent of it, was found merely

in increased government expenditure. Another $42 billion was found in the increased cost of wholesale and retail distribution, which compares with the thriving growth of "middlemen" in the German ination. Still another $41 billion of apparent growth was found in auxiliary activities like nancial services. Not only did fringe activities like these show the largest growth and the most new jobs, but they also showed the most price ination which meant that they were generally more lucrative than productive work. As previously noted, the average price ination in this half of the economy was

27

percent while that in the other half was only

6

percent.

Very little of all this activity added anything to the well-being of the cit izen-consumer if he did not hold a job in these activities. The conclusion is inescapable that very much of the frenzied economic activity of the Ameri can boom must have been for all practical purposes useless. Nonproductive fringe activities, like the overhead of a business, are all useful to a degree, but only to the very limited extent that they help to increase the output of the productive activities by more than the cost of the overhead. Fringe activities in an inationary boom do not do that. In ination, the rst fac ulty that becomes anesthetized is the ability to weigh up real gain against real cost, and consequently the fringe activities blossom and become pos itively parasitic. Useless activity serves as well as any kind of activity to support those employed in it, and that is admittedly important, but even while securing for them their shares of the national pool of well-being the activity adds little or nothing to that pool. The fact of the ination was

59

11 The Inationary Syndrome not true unemployment but rather the millions upon millions of jobs of spurious employment. A spurious job was one that the system could quite well have eliminated altogether, paying its holder the same large amounts for not doing anything at all, and no one would have noticed the dierence. It goes without saying that if the system did not continue paying these cit izens for doing eectively nothing but paid them the same for reapplying their eorts toward something useful, the total lot of all Americans could have been vastly improved. Stated another way, this means that Americans very probably could have worked as much as a day less a week with no loss of either real output or income, if they had simply dispensed with all the useless work and reassigned the productive work among themselves. Determination of what activity is useful and what is not is properly not a question of any one man's judgment.

It is not properly a matter

of the government's judgment when it decides to stimulate this activity and not to stimulate that, and it most certainly is not a matter of my judgment.

Determining what activity is useful is a matter for the sole

decision of the person who pays for it, using his own purchasing power to do so. Useful activity is that which would exist in a free market if there were no articial stimulations or distortions. But the essence of ination is distortion. The invariable habit of ination is to stimulate nonproductive activities at the expense of productive ones, which means that ination is invariably a subsidy by the productive citizens to the nonproductive ones. To say that millions of nonproductive jobs in the ination were useless is not to say that their holders were useless. Exactly the opposite is true. Many of these jobs were among the system's better-paid jobs, and their holders tended to be among the nation's better men.

People are not at

fault in doing useless work. They merely go where the rewards are, and the government's inationary forces are what place the rewards. It is a tragic fact that millions of the nation's best people were led by the government's stimuli to invest their lives in pursuits that perhaps should not have existed, and which might well not exist whenever the government's ination either ended or fell apart. There was no way to measure accurately just how much useless activity and therefore spurious growth the ination had generated. In view of all the magnitudes that have been examined in this chapter, however, it is not at all dicult to surmise that the nation's real growth in individual well-being during the early ination from

60

1960

to

1968

might well have been closer to

zero than to that huge apparent increase in the gross national product. The real improvement in the individual's lot might well have been quite similar to the paltry and dwindling

1.9

percent per year that the real earnings of

production workers grew, which was worse than at any time since World War II. No one could say exactly. The unnerving quality of an ination is that no one knows anything for sure  how much his money is overvalued, how much of his prosperity is illusory, how much of his work is useless and would not even exist in conditions of stability. All standards are lost. In the same way that ination overstimulated useless activity and damp ened true production, ination had a way of turning all values upside down and all principles inside out.

The least useful activities were the most

rewarding, and vice-versa. Skilled workers were steadily less well compen sated in relation to unskilled workers, and there was therefore a chronic and worsening shortage of skilled workers. In the midst of vast spurious employment and considerable outright unemployment, fewer and fewer peo ple could be found to do the useful work, while there were always plenty of applicants for the useless places. Humble economic activities which were nice to have available in their day were simply too humble for the era of the big money and could no longer be carried on in America. Every man can think of his own examples. Useless activities took their place. On the other hand, there were dierent kinds of activities, likewise un qualiedly good in their natural state, which did not disappear but became so overstimulated and overgrown in the inationary distortion as to become a diseased growth of another sort. Education and law were two good ex amples in the American ination. One must tread softly before nding anything so priceless as education to be useless in any manifestation; and one may nd himself forced back on the impersonal rule that what is useful is that which exists without any articial stimulation. After the exercise of all due caution, one nds the hypertrophy of American education in the ination still glaringly real. The government had decided that if education was good, more education must be that much better. Expenditure on education increased twofold by $30 billion from million jobs.

1960

to

1968.

Employment in education increased by

1.7

Higher education alone increased by $14.4 billion, and the

percentage of students among the age brackets from two-thirds, representing

3.4 million more students.

18

to

34

increased by

But education appeared

to represent more activity and less learning than ever before. Education

61

11 The Inationary Syndrome provided occupation for millions of man-years of eort for which the sys tem had no other immediate use, not only of students, faculty and sta but even of construction workers who built the dormitories and classrooms, but that was about all the educational activity seemed to do. The government and the educational system encouraged every young American of every race and every intellectual endowment, or lack of it, to think that higher educa tion was for him. As a result, the educational system found itself ooded with unqualied, uninterested, and disaected students who demanded rel evance from an institution that had always been luxuriously free from any obligation to be relevant; who were insulated by education from ever dis covering what the real sources of social wealth were; and many of whom were progressively incapacitated by education from ever lling a productive place, thus becoming transformed by education into the excess baggage of society.

To the two old kinds of education, which were enabling educa

tion and purely enlightening education, America added a third kind which was disabling education. In the end, the overpriced, overpaid, and over-ex panded educational system found itself in deep nancial trouble which was held at bay only by the government's constantly continuing ination. The hypertrophy of law was somewhat similar. No nobler creation ever sprang from the mind of man than the institution of law, but law is still a social overhead. It creates no wealth directly, although it does lubricate the cogwheels of the economic and social system that does create wealth. Beyond doing that, law can become useless and even a hindrance, and that is what it became in the American ination. The proliferation of laws, legis lation, regulation, litigation, and legal calculation exceeded any imaginable assaying of its worth. Complexity alone in law is pure waste, and every new development in American law increased its complexity and decreased its utility. General litigiousness abounded. New rights of legal action sprang into existence daily. Judges and legislators felt themselves deitically capa ble of rectifying all unhappiness with some kind of legal right of one person against another. No grievance was too absurd to be heard, but the principal eect of hearing each new one was to call forth a thousand more. Every person can choose his own favorite examples of puerile legal contention, among them these: prayers in schools, constitutional rights of clothing and haircuts in schools, rules of conduct in schools, busing in schools, non-bus ing in schools, constitutional rights not to be disciplined, graded, judged or restrained from any act, sex discrimination, age discrimination, discrimina

62

tion against the poor, discrimination against the incompetent, every other imaginable kind of discrimination, obscenity as free speech, evasion of the civic duties of military service, electoral redistricting, labor disputes, rent strikes, freeing criminals for abstract mistakes in procedure, tort liabilities far in excess of any injury that money could make good, securities law lia bilities redistributing losses and winnings among the players in the casino, antitrust prohibitions against routinely innocuous business practices, gen eral harassment of the industrial system that supported us all, and so on. The American legal world was a weird one. It gave occupation and amuse ment to the participants, but not much more. Going so far aeld, perhaps it really sought to improve the general sense of justice, but it was enough to prove that one man's justice is merely another man's injustice and that the pursuit of universal justice is pursuit of a chimera. Possibly some of the strange frenzies of the American ination could be justied as a form of entertainment  law and politics, for example, as a relatively harmless form of sweet aggression, or speculative nance as a Monopoly game for adults.

True entertainment was one of the real

values that had languished rather badly in the ination, but if nance, law, education, and a few others were classied as part of the entertainment industry its growth would have seemed much more respectable. There was much more to the inationary syndrome than merely its ef fects, great and small, on economic activity. The tendrils of the syndrome insinuated themselves even into social, moral, and spiritual life. Surreality in economic life appeared to evoke a corresponding surreality in personal life. Liberation from all the plodding old rules of economic reality, such as the one that two plus two equals only a non-synergistic four, corresponded to a casting o of all the formerly constant values of individual codes, such as reasonable industry, reasonable dignity, reasonable self-restraint and for bearance, and respect for reasonable authority. An omnipresence of money resulted in an omnipotence of money and therefore in the most extreme sort of materialism.

There was hyperactivity in all that the nation did.

Change followed upon change, solely for the sake of change, shock upon shock until there was no shock, whether in personal appearance, personal conduct, arts, obscenity, or escapist addictions. Disaection followed, and general rebelliousness pervaded the nation. There was crime and civil dis turbance and labor strife, and alienation and disunity ran deeper even than the noisy protests of the numerous few.

63

11 The Inationary Syndrome This was the syndrome.

Germany too had seen it all.

It was dicult

to prove that anything so specialized as monetary ination could be re sponsible for all this, and it was dicult even to argue that an ination as moderate as the American could be compared in any way to the extremes of the German. The tendencies, at least, were identical. When the German ination ended, all of this was swept away. When the American ination ended, as it surely must someday, the nation would at last clearly see how much of its social, moral, and spiritual maladies it had owed solely to the ination. When that time came, it might well turn out that the nation had taken the long rst steps on the downward path of outright decline under the smokescreen of the inationary boom.

When all the supercialities had

been stripped away, it might become apparent how very far down that path the nation had already descended.

In all its economic history the

United States had never learned to cruise, but only to accelerate, careen, brake, and smash, and the inationary episode was another of those mad careenings in a vehicle whose windows were as distorted as amusement park mirrors.

64

12 Culprits and Scapegoats It is not dicult to understand why the United States plunged into this bog.

The reasons were much the same as for each of the many other

countries who had taken this road in all the course of history. Ever since ancient Babylon enjoyed its rst ination and its rst balance of payments decit, governments had been discovering and rediscovering the wonders of monetary ination, and every time they did the wonders were all new and breathtaking. Monetary ination always works like a magic elixir at the rst dose. Continuing the doses, or stopping them, is the problem. Nations can always clearly see objectives they would like to reach, such as ghting wars or being prosperous, and they are often willing to spend whatever is necessary to reach them. They are not often so willing to pay up. Ination lets them apparently have it both ways.

Ination is buy-now-pay-later,

and the cost comes due enough later that the causal connection between the purchase and the price is unclear. Politically, any cost postponed may not come due until the other fellow's regime, and perhaps the opposition party can be left to take the blame. Ination is a wonder drug which is extraordinarily dicult not to use in every age of mankind. Unlike most inations, the American ination had a theoretical founda tion as well as a political one. Even Karl Helerich in Germany did not actively advocate ination, but was diverted from his clear better judgment by what he thought was necessity. Most politicians of history, aching to be allowed to use the magic elixir, did so only in deance of warnings that it was theoretically bad. They hoped, as politicians will, that it would not be too bad. Naturally, the politician would much rather hear that the magic elixir is not really bad but good, and this the New Economics told him in

1961.

From the New Economics put into actual practice, a boom and

then ination followed as the night the day. Policies dedicated to promot ing sheer indiscriminate activity without any critical appraisal of its value inevitably produced a rich harvest of sheer indiscriminate activity with out any value.

Learned economists and modern theory answer for much

65

12 Culprits and Scapegoats that in other inations was ascribed to rash, ignorant, or simply powerless politicians. Ination tends to produce a remarkable confusion of culprits and scape goats, and the confusion tends to be similar from one ination to another. In Germany the scapegoats were reparations, speculation, the balance of payments, foreign exchange rates, prices, wages, business, and labor.

In

the United States the scapegoats were the Vietnam war, speculation, the balance of payments, foreign exchange rates, prices, wages, business, and labor. The script read with a familiar ring. The Vietnam war was the most unpopular war in American history and was also the most popular scapegoat for the American ination. It is true that inations tend to occur in big wars, for the reason that the required level of government expenditure is so high that money ination is the only sucient source of nance. But the Vietnam war was only a little war and could easily t into a normal defense budget.

There were no shortages.

Total national defense, including the war, cost no more as a percentage of gross national product at the peak of the war than in no war. Not until

1967,

1959, when there was

well after the price ination was rolling vigorously,

did Vietnam cost as much as the moon race did. One might as justly say that the moon race caused the ination as that the Vietnam war did. The truth is, neither did. Just as a war economy is not necessary to prosperity, so it is irrelevant to ination. To be as prosperous after a war as during, America would have to substitute equal amounts of non-war economic ac tivity and ination nancing. The chronological coincidence of the onset of price ination that had been gathering since

1962

and the increased in

tensity of the Vietnam war was purely accidental. As far as ination was concerned, the Vietnam war was an innocent scapegoat and the end of the war was a false hope. Speculation is another common bogey of an ination. We have already noticed that the preoccupation with buying and selling paper investments is characteristically the prime activity, the prime unproductive activity, and the prime source of rewards in an ination. In Germany, speculators were also much castigated as a cause of ination. In truth, speculation in paper investment serves not to cause but for the time being to help ame liorate price ination. Stock market speculation is a principal relief valve concealing latent ination pressure. Booming stock market prices are them selves a form of price ination, normally the most inated of all, but never

66

thought of as such. The stock market in America harbored a large portion of the latent ination but no one disliked it because they were thinking of paper prots rather than the prices of real values.

Floods of money

which were kept busy inating the stock market were diverted from inat ing other prices. The stock market therefore relieved pressure temporarily from ination elsewhere. The government had articial devices for locking money into investment, such as its growing supplies of government debt and the tax inducements drawing money (about a tenth of the national wealth) into pension funds, and these government dikes around investment markets stored up inationary potential in great brimming reservoirs and out of harm's way. The balance of international payments, the foreign exchange value of the dollar, and foreign competition with American industry were another fraternally related set of villains. For a decade, the decit in the United States' balance of payments was considered to be the economic problem of the country. So it was in Germany. The Kennedy and Johnson admin istrations tried stern measures to treat the symptom by impeding foreign investment by Americans and free currency exchange, even though existing foreign investments from earlier days were a main bulwark of the nation's international position. Nothing worked. Payments decits worsened con tinuously.

That was because payments decits were purely an eect of

ination. If there is excess money, it ows out, as between vats of diering levels of fullness which are interconnected by pipes. More than that, pay ments decits were highly benecial in minimizing the domestic eects of money ination. Net export of money reduces the price ination at home and distributes it instead abroad. If America's payments decits were suc cessfully blocked and its inated money shut up at home, America's price ination would be worse and foreign ination less bad. If dollars held by foreigners from the accumulated old decits should come back to the United States through a surplus of payments, price ination in the United States would be still further worsened. Precisely this took place in Germany at about the middle of

1922,

when Germany's balance of payments moved

into surplus at the same time that its price ination moved utterly out of control. Payments decits while they last are in reality no problem at all but quite delightful for the decit country, allowing it to enjoy a ow of pleasant things like foreign goods and foreign vacations with its constantly cheapening money. Like a fall from a high building, it is not a payments

67

12 Culprits and Scapegoats decit that hurts but the sudden stop. The problems of foreign competition and the foreign exchange value of the dollar were precisely the reverse of those which beset the German in ation. At the time of the German ination, foreign exchange rates were set by a free market, and as a result of the constant ination the plum meting foreign exchange value of the Reichsmark fell even lower than its purchasing power. The mark became grossly undervalued by the ination. In the American case, xed and not free exchange rates operated, at least until

1973,

and the xed rates held the international value of the dollar

constant in spite of the continuous dilution of its intrinsic value by the government. The dollar became grossly overvalued by the ination. This situation enabled Americans to buy up foreign industry and import foreign goods unnaturally cheaply with their plentiful dollars.

Like the balance

of payments decit itself, this was delightfully pleasant for some Ameri cans. On the other hand, foreign competitors were also given an unnatu ral advantage over that part of American industry which was sensitive to foreign competition. The overvalued dollar and competitive disadvantage placed a heavy lid on the prices of all foreign-sensitive products, and this in turn helped enormously to hold the inherent price ination in check in the United States. Low rates of price ination, poor prots, and sluggish wages all correlated closely with foreign-sensitive industries  farm prod ucts, raw materials, steel, automobiles, shoes, chemicals, petroleum, and most other forms of manufactures. Vicious rates of price ination, soaring prots, and rich incomes correlated with industries in which foreign com petition was impossible  building construction, medical care, property ownership and rental, and all forms of services. roughly

100

Simply to compare the

percent rise in construction costs in America in a decade with

the price increases neighboring

10

percent in steel and automobiles is to

see the point. By

1973,

the clamor against unfair foreign competition and unfair for

eign exchange rates reached a bedlam, and the foreign exchange system broke down. It was quite rightly demanded that the overvaluation of the dollar be removed and that the nation's competitive disadvantage be re moved. It was little noticed, however, that any eective step toward these ends, whether by decreasing the exchange value of the dollar or imposing import surcharges or quotas, would release the restraints on prices in the foreign-sensitive industries and allow them to enjoy inherent price ination

68

like that of construction, rents, and services. Precisely this kind of upsurge of price ination did follow hard upon the breakdown of exchange rates into a free market in

1973.

A nation which maintains an overvalued currency

through ination, as the United States did, grants an articial subsidy to service industries at the expense of export industries and other foreign-sen sitive industries. (A nation which maintains an undervalued currency, as Germany was doing at the same time, likewise grants the reverse articial subsidy to export industries at the expense of the rest of the nation.) No real equilibrium could be regained until the inherent ination was allowed to equalize itself and the natural balance of prices among industries to be restored. It follows from what has been said that heaping blame for ination on either business or labor, on either prices or wages, is wrong and unjust. The wage-price spiral is always a familiar whipping-boy for ination, and a variant of it that was fashionable in the United States was the charge that monopoly power enabled big business and big labor unions to raise wages and prices higher than they naturally should have been.

This charge is

easily refuted by the plain facts that all production workers in all industries, including these, fared so poorly in the ination; that prots in the largest and most powerful industries became poorer than ever; and that price increases in these same most powerful industries were the most innocuous in the entire national price spectrum. These industries strove mightily under tremendous handicaps to mechanize, to automate, to compete, and to stay alive. It is an apt measure of the distortion of the nation's values that it lay popular obloquy at the door of those very elements, productive industry and industrial workers, who contributed most liberally to the nation in exchange for the relatively poorest returns. As Lord Keynes observed in a similar context with respect to Germany, industry and labor were "the active and constructive element in the whole capitalist society," and by directing blame against those elements the government was "carrying a step further the fatal process which the subtle mind of Lenin had consciously conceived." Prudence, justice, and prosperity lay not in loading fresh abuse and more onerous shackles on these industries or their workers, but in letting them up o the oor and readmitting them to their former and rightful shares of the national prosperity. At bottom there is always politics, whether in Germany or in the United States or elsewhere. The eternal conict, eternally short-sighted, proceeded

69

12 Culprits and Scapegoats between one productive class and another, especially between labor and in dustry. The instrument of their pursuit of self-interest was political power, and the principal casualties of that pursuit were they themselves. Labor ha bitually thought that good business prots came at labor's expense, indus try that good wages came at industry's expense. Both are wrong. Wages and prots accompany and do not exclude one another. Good prots de pend on the well-being of labor, and good wages on the well-being of busi ness. Constantly seeking their separate advantage, however, both industry and labor were chronically found in the camp of inationary politicians who managed the remarkable feat of oering everyone more and leaving everyone with less. The position of labor in all this was particularly ironic.

Admittedly,

industrial workers were the good horse on which everyone else was riding. Workers' wages did not cause the ination, and workers shared poorly in the inationary riches. But labor had the votes, the Democratic Party was the party of labor, and labor elected the Democratic government that caused the ination. Workers at the bargaining table do not cause ination, but workers at the polling booths can and largely do. The same strange politi cal alliance between stolid labor and mercurial liberals ruled in the United States as it did in Weimar. Liberals, being normally unsullied by acquain tance with real economic work, nevertheless aected a paternal interest in workers. Workers' chosen union leaders endorsed them, and workers duti fully followed. The only possible way of satisfying, even apparently, labor's constant demand for "More!" was to inate, but ination whose ostensible purpose was to improve employment and prosperity of workers beneted everyone else more than it did them.

Not only were productive workers

left out of the inationary gains in income, but as we shall see later the principal targets of the inationary theft were workers' normal kinds of savings such as pension rights, savings accounts, and insurance. Ination was, as it always is, a fraud on workers, and workers were the perfect dupes of their chosen leaders. Seeing none of this, workers grew constantly more militant and less tractable in much the same way as Germany's rebellious labor of the

1922

era.

As the numbers and relative importance of productive workers declined, like those of farmers before them, the time might come when all the pro ductive contributors of society combined  farmers, workers, managers, entrepreneurs, and investors  might be less numerous than the free riders

70

of society. the

27

That time seemed not so far o when it was considered that

million productive workers in the United States were already fewer

than half of all the ostensibly employed Americans.

If that time should

come, it would no longer lie within the political reach of the producers to act for their mutual benet and that of the nation. The closer that time approached, the more urgently the nation needed a timely ability of all of them to see mutuality rather than conict among their interests, and to see that the road to greater abundance for all lay in the direction of demanding less grasping shares for any.

71

12 Culprits and Scapegoats

72

13 The Open Questions We arrive at this point in the history of the American ination, after the bloom had passed and the fruit had fallen but before the eorts of the Nixon administration to contain the ination had begun, and still we essentially do not know where this point was. If there is any lesson to be learned from a study of inations, it is that one never knows where he is in the midst of it, but he certainly is not where he appears to be. All reference points for navigating or xing position have become beclouded.

The apparent

prosperity proves in time to have been illusory, but no one knows until then how illusory. Rewards and values prove in time to have become inverted, but no one knows until then how inverted. The currency proves in time to have been worth less even than it appeared to be, but no one knows until then how much less. The questions raised earlier in this part of the book  whether the degree of the inationary trouble had any direct relationship to the German debacle, and whether the later processes of that debacle taught anything directly useful for the earlier stages of our own  cannot be conclusively answered. The questions remain open. What should be clear beyond peradventure, as we shall presently proceed to examine analytically, is that the direct cause of the inationary plight was the great Kennedy-Johnson orgy of the

1960's.

The ination was not

intended, to be sure, but the deliberate acts of the government were the cause of the ination as surely as they were of the earlier easy prosperity. The ination was the simple price of the boom.

As good as the boom

apparently was, so bad or worse must the ination actually be. The great prosperity had been too easy, was largely false, and in any case was past. Its price in ination would be all too real and was mostly yet to come. As always, the ination which came later was blamed on every sort of extrane ous event that happened to coincide in time with the later emergence of the hidden ination. It was reminiscent of the diculty primitive peoples are said to have perceiving the causal connection between last night's ecstasy and next year's childbirth.

73

13 The Open Questions Notwithstanding the evidence, the diculty persisted. Never yet was a New Economist heard audibly to recant. Never yet was it openly acknowl edged that the deliberate economics of the government from

1962

to

1968

were a failure; not a little miscalculation here or an unne tuning there, but in their deepest fundamentals an unmitigated failure. The nation still struggled to cope with its troubles using essentially the same economics, tinkered with a bit but not superseded. So long as this was true, the nation could be assured of having learned nothing from its ordeal and of making no progress out of it. So long as this was true, even if the nation's ina tionary plight was not yet so grave as it had been in other lands at other times, in the fullness of time it would be.

74

INTERLUDE: The General Theory of Ination

75

14 Welcome to Economic Theory The chapters which follow in this part, dealing with the theoretical basis of ination and kindred subjects, are unfortunately dicult. Controversy over these subjects has survived for millenniums, and absolution seems no nearer to us than it was to Junius Paulus in the third century A.D. It appears that we must endure controversy a while longer. If I may borrow and paraphrase from Lord Keynes' preface to his General Theory: this book is addressed chiey to my fellow citizens who are not economists; I hope that it may be intelligible to economists as well. I have labored as mightily as I could to make what follows both sound and clear. Notwithstanding that, economists may nd these chapters too simple, and disdain them; readers who are not economists may nd them too dicult, or too dull, or both, and skip them. That would be doubly unfortunate. As for economists, I believe that there are numbers of thoughts in these pages which are worth their considering and which are not found elsewhere. But they may do as they wish. As for persons who are not economists, my plea is to persevere. If these chapters in their fullness are too heavy going, try browsing in them more briey to pick up principal ideas.

Every citizen, meaning the machinist

fresh from his lathe and the farmer from his tractor as well as everyone else, nds himself burdened with the duty to master this subject for his own sake if for no other reason. When economic management becomes a matter of popular vote, as it had become in the United States, then the very salvation of the nation depends on each citizen's assuming personal responsibility for enforcing healthful economic policies on his elected leaders.

Political

leaders can be found who will sell absolutely anything the people will buy. Economic experts can be found to do the same. people must lead.

If experts do not lead,

The responsibility stops nowhere short of machinists

and farmers and all the rest of us. And if it is a sobering challenge that ordinary people must guide expertly where experts have lost their way, it is more sobering still to reect that it is ordinary people, and not leaders

77

14 Economic Theory or experts, who bear the consequences and pay the price if the way should remain lost.

78

15 Prices Ination has two dierent aspects.

One aspect is rising money prices of

things that people buy. If ination is thought of as a bad thing, then it is this aspect of ination which is meant.

And clearly this kind of price

ination which is a bad thing is an eect, a result, of something else or a collection of other things. We sense that it does not happen of its own volition, without some systematic cause. If the cause of the evil of price ination can be traced back to some localized and controllable source, then the evil of price ination can be shut o by shutting o the source, provided that shutting o that particular source does not have some other eect which is just as evil as the price ination or more so. The other aspect of the generic term ination is monetary ination, which is nothing more than the voluntary act of the government to allow the existing amount of money to increase. If price ination is an eect whose causes are uncertain, money ination is a cause whose eects are uncertain. And if price ination by itself is bad, monetary ination by itself is neither good nor bad. Simply increasing the amount of money alone bothers no one. Only if a clear link can be established between monetary ination as a cause and price ination, a bad thing, as a result, can monetary ination be convicted as itself a bad thing. Further, we must distinguish between increasing prices of some things, which is not necessarily price ination, and an increasing general price level of all things as an aggregate, which alone is price ination. To take the most painful examples: if prices rise drastically in things like food or medical care, the least avoidable of all necessities, there is still no true price ination if prices of other things have declined by a compensating amount, even though people as a whole do not care as much about the things which now cost less as about the food and medical care which now cost more. The farmers and food industry, or the nurses and doctors and medical industry, have simply succeeded in out-competing the other industries.

This they

are entitled to do. If this changing balance of prices grows extreme, it may

79

15 Prices require economic remedies of one sort or another, but it is not ination and does not require anti-inationary remedies. When we speak of ination we must always have in mind whether we mean price ination (a bad thing, an eect) or monetary ination (a neutral thing, a cause); and when we speak of price ination, we must speak only of true price ination of all things and not merely of rising prices of some particularly necessary thing. What then causes true price ination? More fundamentally than that, what determines prices of all things as an aggregate? The most obvious answer would be that prices of things are set by the people who sell them, or at most that prices are set jointly by the people who sell and the people who buy. Since all sales involve only two parties, buyers and sellers, who by mutual agreement x the price which is acceptable to both of them, it would appear that between them they have absolute power to set prices as high or as low as they please. It is this sense of the joint autonomy of buyers and sellers over prices which leads to the feeling that prices are set by their whim and are subject to no reliable laws.

It leads further to the feeling

that price ination may be spontaneous and aimless like a self-governing sacred cow in the streets of India which rises, wanders about, and subsides entirely as it pleases. The quaint notion that buyers and sellers determine prices as their vol untary act is largely false. The genuine feeling of each buyer and seller that he is free to do as he wishes when he agrees on a price, and therefore could do something else if he wished, is largely an illusion. Buyers and sellers of any one kind of thing, such as food or medical care, do have some freedom to increase the prices of that one kind of thing; but every dollar more that a buyer spends for food or medical care is a dollar less that he can spend for something else, and every increased price of one thing must come out of a decreased price of something else, unless someone provides some more dollars so as to allow for an aggregate price ination. Buyers and sellers of any one thing therefore have some freedom to set their prices but not as much as they think they do. Buyers and sellers of all things together have mathematically no power whatever to increase prices beyond what are determined for them by external forces. Prices are no self-governing sacred cow blundering aimlessly through our garden party and subject to no law or restraint. Prices as an aggregate are mathematically determined by the total amount of money which is available for spending in a given period of time, in rela

80

tion to the total supply of all values which are available for purchase with money in that period of time.

There are many vitally important rene

ments still to come, but the law of prices is basically as simple as that. To illustrate, suppose that we have a simple economy which has only one gen eralized thing of value available per day, a total money supply of $10, and a normal preference by the holders of the money to turn over (or spend) the money supply once per day.

It is mathematically impossible for the

price level of that economy's one thing of value to be anything but $10 per unit. In this illustration, the aggregate supply of values is one unit per day, and aggregate demand is $10 per day. The aggregate price level must equal

aggregate money demand per day ($10) divided by the aggregate supply of

values per day (i unit), or $10 per unit.

This is nothing more than a routine application of economies' basic law of supply and demand. That law says that for a given supply and a given demand, only one equilibrium price is possible. If supply rises, price falls. If demand rises, price also rises. When this law of supply and demand is applied to individual kinds of goods, such as beef and pork, or steel and aluminum, demand is not a mathematical quantity but is subject to many psychological choices between alternative purchases, such as beef and pork. But when the law is applied to a comprehensive supply of all values, in which all alternative choices have been included and therefore eliminated, aggregate demand is.

nothing but money per unit time.

Covetous eyes

peering in at a shop window, but with empty pockets, may be psycholog ical desire but they are not demand; money in hand and ready to spend, however jaded or indierent, is demand. The quantity of money is both denite and determinable. The Federal Reserve System in the United States publishes it every Thursday.

The

correct denition of "money" is somewhat arguable, but to work properly in this hypothesis it must mean that which people use to buy things of value with, but is not a thing of value itself.

That in turn includes all

dollar bills and coins and all checking account deposits, and nothing else. This money supply in the latter part of

1973

was moving upward through

the vicinity of $260 billion in the United States. One psychological factor still remains in the price equation, and that relates to the rate of use of money. Money quantity alone does not deter mine demand or prices; money available per unit time does, and that in turn depends on how fast the holders of the money supply choose to make

81

15 Prices it available for purchases. By taking the total supply of all values for sale into our accounting, we have eliminated all psychological choices between one possible purchase and another, but we have not eliminated the psy chological choice between spending and not spending at all, that is to say between purchasing from the supply of values and holding the money itself. This factor can be thought of in dierent ways. Lord Keynes called it liq uidity preference, looking to the cash balance relative to purchases which the average holder of money liked to keep on hand. The reverse of this is called the -velocity of money, looking to the volume of purchases relative to the supply of money. In our illustration, we assumed that the holder of our money supply had a liquidity preference for a cash balance equal to one day's purchases, so that the resulting rate of turnover or velocity was

1.0

per day. No external force dictated this liquidity preference to the holder of the money supply, however, and we had no way of knowing it until we had statistical evidence after the fact. Of velocity and liquidity preference we shall have more to say later. Notwithstanding the interposition of the velocity of money, which is a troublesome factor because it is variable, psychological, and not readily determinable, we have a law of what determines an aggregate price level. It may be restated as a simple equation (the only mathematical equation which this book contains): Price level = (Money quantity X Money velocity) / (Supply of all real values) Price level moves in direct proportion to the quantity of money and to the velocity of money; price level moves in inverse proportion to the aggregate supply of real values. If money velocity is habitual and remains more or less constant, and if the supply of all real values is given and remains more or less constant, price level depends on the quantity of money. Prices are not matters of self-governing caprice. Concrete numbers can be attached to these concepts. If the money sup ply in the United States in

1973

was about $260 billion, and at a conserva

tive estimate every dollar was spent an average of

50

times per year, then

the prevailing aggregate money demand had to be the product of the two multiplied together, or $13 trillion per year.

This was the total amount

of purchasing power available for all the uses of money, including not only gross national product or nal sales (only about $1.2 trillion per year) but also intermediate sales, buying and selling of stocks and debt and all other

82

property, paying taxes, and making other non-sales transfers of money. The aggregate of the price tags attached to all these transactions either must rise high enough to absorb exactly the total available purchasing power, or be held low enough to t within it. They are in equilibrium when, and only when, they match. What we have stated to explain prices is a form of the quantity theory of money. This theory is as old and persistent as economics itself, dating from at least the sixteenth century and French royal philosopher Jean Bodin. Its fundamental validity went largely unquestioned through most of the history of economics. Most of the great gures of economics, including such men as Locke, Hume, Mill, and Ricardo, worked with and improved upon it. The great economists Irving Fisher and A. C. Pigou, American and English respectively, advanced its progress in the rst quarter of the twentieth century. Before Lord Keynes set all of the New Economists ying o on a tangent in

1936,

the quantity theory was a basic part of the equipment

of every important economist. After that time, it fell into general disuse. Most orthodox modern economists denied the quantity theory. Professor Milton Friedman made himself an evangelist of innovation preaching what had been gospel for millenniums. But Lord Keynes himself was one of the clearest of all expositors of the quantity theory of money. Writing in

1924

in A Tract on Monetary Reform, he endorsed the theory and said that it was foolish to deny it. Karl Helerich in Germany was also an excellent expositor of the quantity theory. He caused the German ination by failing to apply his own precepts. The issue of the quantity theory comes to this: the progressive economics of the thirty years after Keynes repealed all previous economic wisdom on this point, including that of Keynes.

If the accumulated learning of the

centuries was right at all, modern economics were wrong, and vice versa. To repeal history in this way may sometimes be right, however drastic, but the extremity of the act counsels caution.

83

15 Prices

84

16 Ination If quantity theory explains prices, then an application of it also explains price ination. If what has been said is correct, then the sole root cause of price ination is monetary ination. In its simplest form, this is to say that if the money supply increases by

10 percent while the supply of values

and velocity of money remain constant, the general price level must rise by

10

percent. It is far too simple, however, to dene monetary ination as merely an

increase in the supply of money. There are three variables at work on prices, not one; they are not only money supply but also money velocity and the supply of real values.

An increase of

not inationary if there is also a values, or if there is a

10

10

10

percent in the money supply is

percent increase in the supply of real

percent decrease in velocity. By the same token,

no increase at all in the money supply would still be inationary if there has been a

10

percent increase in the velocity of money but no increase in

the supply of real values. Any one of the three variables can move prices in either direction, but only one of the three  money supply  is subject to the control of the government. To prevent ination and achieve price stability, this one controllable variable must be changed to oset changes in either of the other two. Monetary ination can be dened as allowing to exist any money supply which is greater than the quantity which exactly does this.

An inated money supply might actually be a money supply

which is decreased, but not decreased enough. Monetary ination dened in this way is in fact the sole root cause of price ination. . . . Monetary ination is the cause of price ination, but the response of eect to cause is far from instantaneous. ination of rise by

10

10

If there is a sudden monetary

percent, experience tells us that prices do not immediately

percent, nor in fact may they rise at all for a considerable time.

The price equation as we have stated it does not appear to allow for this, and if it can be in error on this point perhaps it is wrong altogether. The diculty is only apparent. The price equation in the simple form

85

16 Ination only operates in equilibrium conditions. In disequilibrium, such as imme diately after a monetary ination has occurred, the formula can only state what prices will be when a new equilibrium is restored, and not what actual prices are at any time in between. Consider how a monetary ination actually works. In our earlier exam ple, a money supply of $10 was turning over once per day so as to price an

output of one unit per day at $10 per unit. Conditions were stable. Any seller who wished to raise his price would have forced some other seller to receive a smaller price, or the buyer to spend faster than he desired. More likely, the price-increasing seller would have lost his sale, so he refrained from raising his price and prices remained constant.

This is the essence

of equilibrium. If at this point the government should double the money supply to $20, it would appear a priori that equilibrium will remain undis turbed if, but only if, the government also prevails on buyers and sellers to double all prices to $20 per unit. But this is not what happens when there is monetary ination. No one changes prices automatically, and in fact the government strives to restrain them from doing so; no one announces that there has been monetary ination, and in fact it remains dicult to detect. In these circumstances, the equilibrium level which prices must eventually nd will still be $20 per unit as a result of the doubling of the money supply, but for the moment actual prices will remain at $10 per unit.

The purchaser who holds the enlarged money supply of $20 has been

accustomed to paying only $10 for a day's supply of values, and he has no

real desire to pay $20 for the same thing without being forced to do so. He has a choice of either doing that or holding his $20 money supply for two

days instead of one. He will always prefer to do the latter. He is apparently twice as wealthy as he was previously.

The value of his money in terms

of actual prices has not declined, but he has twice as much of it. He can spend his customary $10 per day for output, which was previously all the

money he had, but now he has another $10 left. The velocity of his money will fall in half, aggregate money demand (quantity multiplied by velocity)

will remain the same, and prices will not change. The only unstable factor so far as the buyer is concerned is that he is holding twice as large a money balance as he really wants. On the opposite side, the seller in our economy has been charging $10 for a day's output of values, exactly meeting demand, and he hesitates to raise his price for fear of losing sales. He is not informed that the equilibrium

86

price for his output is now $20. Only gradually will he sense that there is more money demand around than he is laying claim to, less reluctance to pay his price than there was at the $10 equilibrium level. He will gradually begin to feel out this new demand by raising his prices, and the buyer holding surplus balances will gradually begin to pay them. Actual prices gradually make good the equilibrium level which the $20 money supply dictated, and the price ination becomes realized. The original increase of the money supply was what caused the ination, and the buyers and sellers merely served as agents to put it into eect. Modern conventional economics classies causes of ination as "cost- push" or "demand-pull" forces. This distinction is purely descriptive and not analytical.

It merely states which of the two parties to an ination,

sellers or buyers, is pushing or pulling the harder to get their mutual prices up to their preordained equilibrium. If sellers are the more eager to claim the full prices which aggregate available money would justify, the ina tion will be "cost-push"; if buyers are the more eager to reduce their cash balances and bid up the prices of available output, the ination will be "demand-pull." As a means of analyzing the basic causes of ination, the distinction is utterly useless. The original increase of the money supply, temporarily masked by a re duction of money velocity, was what set the equilibrium level of prices higher than their actual level and thus created the inationary bias. The dierence between the actual price level at any time and the higher equilib rium price level is the unrealized depreciation of a currency, and the living process of working upward from the lower to the higher is the process of living an ination. No meter anywhere has yet been devised to read out the unrealized depreciation of a currency, but if it were this meter would inform us surely where an ination is going. The direction of the equilibrium level and the breadth of the gap indicates which way prices must move and how far at a maximum, but not necessarily when or how fast. Price ination would tend to be more rapid and more immediate, the more extreme is the unrealized depreciation, but this is only a tendency. It depends on the minds of buyers and sellers.

Price inertia is very strong, dicult to get

moving and dicult to stop. If sellers are suciently unaggressive about raising prices and buyers suciently willing to hold their excess money rather than bid up prices with it, prices may remain steady even with a large inherent depreciation in the currency. Equilibrium may be not at all

87

16 Ination quick to emerge. To the contrary, an implicit disequilibrium may be persis tent and even quite stable. Nevertheless it is the underlying money demand available which dictates to buyers and sellers which way their prices must go and where they must arrive, leaving it to them to decide when and at what speed they will accompany one another to that point.

This much

autonomy and no more do buyers and sellers have when the makings of a price ination have been presented tc them by their government. This analysis corresponds with the evidence of every important ina tion of history, including the German ination and the American ination. Money supply increases, money velocity falls behind, and prices remain steady.

Later money velocity recovers, prices begin to rise, and equilib

rium eventually returns at the level xed by the original money supply ination.

Transitory phases like the Korean War ination may occur on

psychological velocity alone, without a money supply basis, but they do not detract from the validity of the analysis. As Professor Milton Friedman observed whenever anyone would listen, as well as whenever no one would listen, ination is always and everywhere a monetary phenomenon. No one can cause an ination but the government, and neither more nor less is required to stop an ination than that the government stop causing it. This has been true since the earliest origins of ination in the forests of the Stone Age. It was true of Germany. It was true of America. Professor Friedman's solitary struggle to regain acceptance for the obvi ous surely attests to the lonely estate of being even partly right. A whole generation of modern economists was trained up to positions of respect and inuence making no use of quantity theory as it developed over the cen turies. Economists of the Keynesian school would ght to the death against the implications of quantity theory: to wit, that the fantastic German in ation of

1923

was caused by ination of the money supply, or that the

operative agent of their own sophisticated Keynesian techniques was also monetary ination.

Alas, what is oldest, most obvious, and most rmly

accepted in the past is not always wrong, and ghting to the death against the obvious is sometimes fatal.

88

17 Velocity Money has a well-known dual function.

One function is to serve as a

medium of exchange to help match up the sellers and buyers of various kinds of values without the need for exchange in kind, or barter. The other function is to serve as a store of value in itself. The rst function is money in motion, the second is money standing still. The only truly legitimate function of money is the rst, the exchange function.

Without the need

for a medium of exchange, there would be no need for money. As stores of value, other kinds of property are just as good or better. Money is not properly a store of value because it has no intrinsic value of its own. It has no utility except in exchange. Money which is being used as a store of value is money which is bars de combat for the time being. Nevertheless, the use of money as a store of value is traditional and can easily be tolerated, provided that it is adjusted for. If it were not for the demand for money as a store of value, the money supply would be nothing more than the average "oat" between transac tions, that is, a momentary balance on hand between a receipt of money income and a money expenditure. In this case, the average holding period for money would be very low, much lower than it actually is, and velocity would be high. At the extreme, if the eciency of use of money in making transactions were increased to perfection, so that all exchanges were in stantly matched up and liquidated, and if there were no demand whatever for money as a store of value, the velocity of money would be innite and the only non-inationary money supply would be zero. Conversely, if the money supply did not turn over at all, meaning that every citizen had a complete preference to use his money as a store of value and refused to use any of it in transactions, the velocity of money would be zero and the proper quantity of it innite. In practice, normal liquidity preference rep resents a combination of a normal oat between transactions and a normal amount of money held as a store of value. Much learning has been expended on trying to determine what factors

89

17 Velocity govern liquidity preference. Keynes, for example, after close analysis, found these factors to be basically the "income motive" (the oat between receipts and expenditures), the "business motive" (working capital), the "precau tionary motive" (reserves against reverses), and the "speculative motive" (anticipation of changes in the value of money). Others have expanded on this study.

Indeed, the principal reason why Keynesian economists have

abandoned the quantity theory is their belief that the behavior of liquid ity preference and velocity is so unruly as to make the whole investigation futile.

Evidence does not support this belief.

The reasons why people

change their liquidity preference make an engrossing academic study but not a reliably predictable force. Fortunately, it is not necessary to predict or control liquidity preference nely.

It is sucient to know that it can

change, to keep a weather eye on its changes, to measure the changes, and to compensate for those changes that appear to be permanent. Ination can be a purely velocity ination as easily as a quantity ination. The initial Korean War ination was an example of this, and the later stages of the German ination were also based mainly on a skyrocketing velocity. If for any psychological reason the people's liquidity preference should fall by half and velocity double, equilibrium prices must surely double even though money supply remains unchanged. The reverse is true if people's preference shifts drastically toward holding money and not spending it. Prices must fall. A purely velocity ination is usually quite volatile.

If velocity rises

sharply for some psychological and spontaneous reason, unaccompanied by money quantity ination, velocity will usually return to its norm about as quickly as it departed from it. This would have happened in the Korean War ination if money quantity had not advanced to meet velocity. Sharp velocity inations left to themselves are almost never permanent.

This

truth is precisely the opposite of quantity ination, for a price rise based on money quantity is as irrecoverable as money quantity itself. Unlike money quantity, money velocity cannot be measured even mod erately well.

One crude indicator of velocity is called "income velocity"

and is the ratio of national product to money supply. In the United States in

1973

this number showed about

4.9

times turnover of money per year.

This measure compares only one part of a nation's values, its gross national product, with a total money supply used for many other purchases, and for that reason it is a hybrid and completely invalid concept. Another measure

90

is called "transactions velocity" and is the ratio of the total dollar volume of all payments made by checking accounts to total checking account bal ances.

This number was of the order of

50

to

90

in

1973,

depending on

whether or not higher-velocity accounts in nancial cities were disregarded. This measure is somewhat closer to the true idea of velocity, although it ignores the use of dollar bills and includes many kinds of check transactions that are not sales, and for these reasons it too fails to show velocity pure and true. Nevertheless, transactions velocity is probably the best measure of velocity available. In spite of these serious defects of measurement, there is something that we can learn about velocity. It happens that both indicators, income ve locity and transactions velocity, were in rough agreement on the rate of change of velocity, which was considerably more important than its abso lute speed. Moreover, indications are that velocity and liquidity preference do not change nearly as erratically as they theoretically could. Trends in velocity are reasonably constant. According to both measures, velocity in the United States increased steadily from a low point in war, through

1973.

1946, just after the 279 percent,

Transactions velocity increased by at least

or a compounded rate of

4.8 percent per year, 27 years.

and this rate of increase was

fairly constant throughout those

Our price equation informs us that if the total supply of real values increased after the war no faster than the same

279

percent as money ve

locity, velocity alone would have supplied all the additional money demand that was needed, and money quantity could not have increased at all with out causing ination. In fact, however, the supply of real values in gross national product, at least, grew considerably more slowly than that rate, and money supply also increased by

141

percent during the same

27

years.

Aggregate money demand (quantity multiplied by velocity) was thus more than nine times as great in

1973

as in

1946,

and if the total supply of real

values in the United States did not grow by this much there must inevitably be ination. Money quantity and velocity theoretically could move independently of one another, but in practice they do not.

Quantity leads, and velocity

follows. At the beginning of an inationary cycle, velocity declines while money quantity increases, thereby osetting one another and masking the true inationary potential. many and America.

This happened during the wars in both Ger

It happened also in Germany's prosperous expan

91

17 Velocity sion of

1920.

We saw why this happened in our simple example, because

money holders were temporarily willing to hold their excess money, slowing down velocity and leaving prices unchanged. Later, in the mid-course of an inationary cycle, money quantity and velocity both increase, thereby compounding the inationary eects of one another. After overcoming its initial inertia, velocity does not merely return to its former rate but may accelerate past it. People naturally wish to hold money less and to spend it faster when they see its value falling. At the end of an inationary cycle, velocity rises faster than money quantity, though only for a limited time after the quantity ination stops. All of these relationships can be traced out in reverse in a deationary cycle. Monetary contraction began in

1928 in the United States,

but veloc

ity rose for a time to compensate for it and the deationary eects were masked. Deation took hold in

1929

and both money quantity and veloc

ity began to fall together. Prices and prosperity fell with them and much more steeply than quantity alone.

At the depth of the Depression, long

after money had stopped contracting, the hoarding of money  simple low velocity  persisted and frustrated all eective recovery. The role of money velocity in the German ination was extremely impor tant, but it dovetails with all these general principles. Velocity decreased during both the war and the

1920 boom, hiding the quantity ination which

was forging ahead at both times. Velocity started to rise with moderate vigor in the summer of

1921, when Germans began to smell a governmental

rat, and that signaled the gradual emergence of the latent price ination. Velocity took an almost right-angle turn upward in the summer of

1922,

and that signaled the beginning of the end. An explosive rise in velocity thus accurately marks the point of obliteration of an inated currency, but it does not cause itself. People cause velocity, and they only cause hyper -velocity after prolonged abuse of their trust. The German mark had been undergoing massive dilution for over two years, and the people only at last realized it when they turned on the velocity. At the end in

1923,

the veloc

ity of German money began to approach innity, because paper bills could easily change hands hourly or faster and practically did. In money velocity, what goes up must come down but only when the cause is removed. Whenever quantity ination should stop, velocity must eventually fall to normal.

In Germany, that would have been a problem

in itself, because prices would have to fall by the same factor that veloc

92

ity did unless money quantity should be increased again (i.e., inated) to compensate. An interesting dilemma, that, but one that is neatly avoided if the people are not driven at last into desperation velocity. High velocity was the cause in Germany of the remarkable coexistence of soaring prices and a low and falling real value of money supply. This in turn caused the government's bemused thinkers to say that there was no ination. The government's erroneous response was to try to maintain real balances by increasing money supply. The government gave chase to velocity with quantity, but, like a contrary mule, velocity dees chasing. If chased, it runs away faster, and the top speed of this particular mule nears innity. On the other hand, if the government just turns around and walks the other way, this mule comes galloping back and licks its hand. The fact that the collapsing German ination rested mainly on velocity, a volatile and psychological phenomenon, is not reassuring and does not mean that the ination was unique to its own circumstances. It is a warning never to inate even distantly near the point of stampeding the people, and if they do stampede do not follow. Money velocity is thus much the more sluggish, in the beginning of an ination, of the two partners in aggregate demand, quantity and velocity. Later on, it is much the more prone to explosion. But velocity presents us with still another obstacle to gaging inationary potential accurately. The problem is that it is not really actual velocity at all that we would like to know for our price equation, but equilibrium velocity.

Actual velocity is

no more than a rate of ow that happens to be occurring at the present moment. The price equation using actual velocity has often been criticized, and quite properly, as a tautology which discloses nothing about ination ary potential.

The mathematical relationships are so inviolable that the

equation using current velocity must balance out at the current price level, telling nothing about where the price level is bound. On the other hand, people's underlying liquidity preference is an equilibrium cash balance that people would like to arrive at, not what they have succeeded in arriving at to date. Equilibrium velocity is to actual velocity as a pressure is to a ow, or as voltage is to amperage in electricity. The rate of ow is always moving toward where the pressure is now. If we could know and substitute equilibrium velocity for prevailing velocity in our equation, we would have no tautology at all but an infallible calculation of equilibrium prices and inationary potential.

93

17 Velocity All of these eects were apparent in our earlier example.

When the

money supply doubled, actual money velocity halved, and the price level remained unchanged. If we had inferred from this that buyers' underlying liquidity preference had doubled, we would have concluded that there was no inationary potential but we would have been wrong. In all likelihood equilibrium velocity, which is based on buyers' inherent liquidity prefer ence, remained as high as actual velocity had been previously, and if so equilibrium prices were twice as high as actual prices were. Unfortunately, if actual velocity is dicult to measure, equilibrium ve locity is impossible. The best we can hope to do is to deduce equilibrium velocity from surrounding circumstances including the behavior of actual velocity. The usual relationships between money quantity and money ve locity will also help considerably.

Velocity is always a follower.

As long

as quantity ination is continuous, money-holders continuously hold more money than they want, however little that may be, and actual velocity is continuously lower than equilibrium velocity.

No matter how high or

rapidly velocity may have risen, so long as monetary ination continues it is always lower than it is going to be and therefore always understates inherent inationary potential.

94

18 Aggregate Values The third great determinant of prices, after money quantity which is deter minable and money velocity which is not so determinable, is the aggregate supply of real values available for money in a given period of time.

In

short, the larger an economy is, the more money it needs to do its work. A large money supply is not absolutely inationary. It is relative. Prices are inversely proportional to the supply of values, money quantity and velocity remaining the same. If the supply of values increases but money does not, prices must decline; this happened in the United States in the last quarter of the nineteenth century and was the source of the money pains of that era. If the supply of values increases, money may and should also, without inationary potential. Traditionally, in the evaluation of this relationship, the supply of values is equated to the gross national product, which is the economy's entire output of current goods and services in a given time. This is a mistake and a serious one. Gross national product is obviously important, but it is by no means the entire supply of real values available for money purchase. To assume so is to disregard all of the existing capital wealth of the nation. A man who has money in hand and has decided to spend it has two prin cipal kinds of things he can spend it on. One kind of things, but only one, consists of current goods and services, the national product. The second kind of things consists of all existing property, including land and build ings, used goods, productive plant and equipment, and all sorts of paper property such as stocks, bonds, mortgages, savings accounts, insurance, and commercial paper. This second category of values lies entirely outside the national product and corresponds to the national wealth. Purchases in this category also correspond to what a layman is likely to mean by "invest ment." When an economist speaks of investment, he means the formation of new capital assets like construction of factories or equipment, but that is a part of national product.

When a layman speaks of investment, he

probably means the purchase of an existing capital asset like stock or a

95

18 Aggregate Values bond. The purchase and sale of capital assets obviously requires the same quan tity of money to serve as its medium of exchange as the sale of an equal volume of national product. As a result, at any given time some part of the total money supply is employed in national product transactions and another part is employed in capital transactions.

There are at all times

two distinct money supplies and two distinct velocities of money, one each in the market for national product and the market for national wealth. The comparison between the total supply of money and the gross national product alone, as is made in computing the so-called "income velocity" of money, is meaningless. Each of the two separate markets must abide separately by the law of prices.

The aggregate price level in each market must be higher as the

quantity or velocity of money in that market rises, and lower as the supply of values in that market rises. But there is no dam between the markets other than the habits of the people, and these may change. The distribution of money demand between the two markets is not xed.

Any man may

move his personal money supply from the stock market to automobiles and back again.

So too may the people as a whole.

Consequently the two

markets must comply with the law of prices not only separately but also as an aggregate. As net money demand moves from one market to the other, prices must go down in the rst and up in the second. The exact division of money supply between national product and capital markets is extremely dicult to estimate, but the share employed in capital markets in the United States was not small. Stock sales on exchanges alone in the one year of was

23

1968 required cash transfers of almost $200 billion, which

percent as great as the annual national product and about equal

to the total money supply. Of far greater importance was the aggregate American debt structure which amounted to $3.2 trillion in money claims by

1971.

Even if the average maturity of this debt structure were as long

as two years, the constant renancing of this debt structure would require cash transfers of $1.6 trillion every year, which would be half again larger than the annual national product and almost seven times the total money supply. It is true that the need for cash in capital markets is diminished by the extremely high velocity of money in nancial centers; transactions velocity in New York, for example, averaged almost one complete turnover every business day, which was more than four times as high as the velocity

96

of money in non-nancial centers. Nevertheless, it is not at all dicult to suppose that the money supply required for capital markets in the United States might be fully equal to the money supply engaged in selling national product. The signicance of all this is that the use of money in capital markets is a principal repository of inationary potential. Monetary ination invari ably makes itself felt rst in capital markets, most conspicuously as a stock market boom. Prices of national product remain temporarily steady while stock prices rise and interest rates fall. This happened at the commence ment of the German inationary boom of

1920,

and it happened again at

the commencement of the American inationary boom from

1962

to

1966.

Indeed, every monetary expansion in the United States since World War II was followed by a stock market rise, every cessation of monetary expansion by a stock market fall. Conversely, every stock market rise was preceded and accompanied by money ination.

Bull markets rest on nothing but

ination. The market fall following tight money merely brings the market back to its real-value level. It is not dicult to understand why this is true.

Virtually all, and

not merely a proportionate part, of the excess money demand created by a monetary ination goes temporarily into the capital markets.

In our

earlier example, the holder of excess money could either force up the prices of national product (price ination) or hold the excess money longer than usual (low velocity), neither of which he had any wish to do. What he is actually most likely to do with the excess money is to buy himself some stocks, bonds, or savings accounts, in other words to "invest" the money or put it into the capital markets.

This must force up the prices of real

values in capital markets, to be sure, and this in turn is one form of simple price ination, but no one thinks of it as such because no one is thinking of real values. One man's price ination is another man's capital gain, and even the rst man does not mind it if he is getting his capital gains too. The excess money which is happily at play in the capital markets is money which is not yet distressing the prices of national product, where it might hurt. Notice what has happened in mathematical terms. In our original exam ple, there was a partial money supply occupied with purchasing national product equal to $10.

Velocity was one transaction per day, output was

one unit per day, and resulting prices were $10 per unit.

Suppose now

97

18 Aggregate Values more complexly that there is another separate money supply of $10 occu

pied with trading capital assets, making a total money supply of $20. Now if the money supply is doubled to $4O and all of the extra $20 goes into

the purchase of investments, the money supply in the capital market will have trebled, not doubled, and prices there will at least treble too, perhaps more because of speculative high velocity. Money quantity and velocity and therefore prices in national product will remain temporarily unchanged. In due time, there being no dam between the markets, a leakage of excess money demand back from capital markets into national product will occur. There will always be that spoilsport in the capital casino who will take his winnings and buy national product with them. There will always be that footslogger selling national product who senses that there is surplus money demand over yonder among the capitalists and demand some of it by raising prices.

It is inevitable.

Excess money which starts out in

the capital markets winds up back in national product. If luck is good, the excess money will merely redistribute itself proportionately between the two markets. In the example, national product prices will double while capital prices fall back from three times their original level to merely twice their original level. By coincidence, these are precisely the relationships that held good in the German boom of

1920-21; the money supply doubled, the stock

market at rst trebled but then skidded to double as the prices of national product began to rise. If luck is bad and people lose faith in all kinds of capital investments, there may be a general exodus of money from capital markets which will make the price ination in national product much worse than the money ination would seem to justify. This too happened as the initial acceleration of the German ination gathered speed. What is clear is this: national product and national wealth are roughly equal partners in competition for aggregate demand; national product is by no means predominant; the two are inseparably connected as if by conduits, so that rising prices in one must be compensated by falling prices in the other, or else there is ination; the distribution of money demand between the markets is neither xed nor reliably stable; and the entire amount of an ination in the capital market represents inationary potential which must be realized at least proportionately in national product before the potential can be considered liquidated.

A boom in capital prices which

exceeds the growth of real capital values and is not accompanied by falling prices in national product is an inationary danger signal of the rst order.

98

The custom of ignoring capital markets and looking solely at national prod uct in relation to total money demand is theoretically unfounded, may be dangerously tranquilizing, and in inationary conditions will always lead to underestimating the magnitude of inationary potential.

99

18 Aggregate Values

100

19 Real Values Prices depend on the total supply of values in a country compared with its money demand, but real values are not the same thing as ostensible values. Gross national product and sales of capital assets tend to be taken into account at their face values, but this is highly misleading.

The relative

prices of one thing and another which prevail in one set of conditions, such as ination, are not the same as would prevail between the same two things in another set of conditions, such as stability.

Something which

commands a high price and has a high apparent value in ination may not command any price and may have no value in stability. If ostensible values are higher than real values, the dierence represents spurious values. Spurious values have the eect of dampening ination and understating inationary potential, because they make the supply of values look larger and price equilibrium look nearer than they actually are. Money occupied in buying spurious values is money which is not forcing up the prices of real values as high as they should be. In an ination, every nook and cranny of the value supply has its cache of spurious values which help to disguise and conceal the ination. National product itself is chronically overstated in an ination. Earlier, we discoursed at length on the vast volume of useless but supercially economic activity which ination engenders.

Most of the growth in an

ination is shown in these activities. The most inated relative prices be come attached to goods and services of the most marginal real value, so that attaching face value to national product becomes doubly deceptive. It is possible that real values in the United States did not grow at all even while apparently growing by one-third. Whenever non-inationary condi tions should supervene, prices and demand for spurious values collapse like bubbles, shrinking the apparent supply of sale-able values, worsening the ination in real values, and placing price equilibrium farther away than it apparently was. Spurious values thus operated as a hidden storage tank for inationary potential. Surplus labor is a special case of overstated value.

101

19 Real Values Whenever productivity rises so that less labor is required for the same out put, the total supply of real values increases even though actual production may stay the same. The reason is that the total value of output is the same as before, but now we also have an additional supply of surplus labor which has been released from producing it. Surplus labor has a real value, of that there is no doubt. The more there is, the more valuable is the nation. But the correct valuation of this surplus labor is another matter.

If surplus

labor demands a higher and higher price for doing less and less, which is precisely what happens in inationary boom, gross national product ac cording to face value appears to go up and up but the supply of real values according to value oered per dollar actually goes down. Education works like surplus productivity.

If education of producers

results in greater capacity to do useful work, the supply of real values increases more than population does; but if over education results in a decreasing willingness to do useful work, the supply of real values declines. The people as a part of the supply of values are worth less than they were before. In this way, both education and improved productivity may increase the supply of real values up to a point, but after that point they may often actually diminish it. Capital values are equally overstated in an ination. For every spurious activity in national product there is a spurious investment value available in capital markets. The most marginal of all investment values are those whose ostensible values rise highest. Capital values inherently cannot grow as buoyantly as national product can.

One-sixth of national wealth is

land, whose quantity is xed and whose real value is virtually incapable of increasing. Another large part of national wealth consists of buildings and durable goods which depreciate in value constantly through use. Still another part of capital values consists of natural resources which are subject to permanent depletion. As the end of any nation's supply of a valuable resource such as iron or oil comes into sight, a permanent reduction of that nation's total supply of real values is inevitable. The real values of capital wealth are much more prone to fall and much more dicult to lift than the values of national product. The total supply of all values, which includes capital values, inherently cannot grow as quickly as national product alone can grow. The fraction of all capital values which is available at any given time uctuates.

102

Only a small part of the national wealth is for sale at any

one time, but it is that small part that enters into the total supply of values at that time. In stable economic conditions, the proportion of the total wealth available for sale at any time would probably be reasonably constant. In ination, the turnover of capital assets increases. The total supply of real values is swollen by a disproportionately large segment of the capital wealth. This eect serves to understate the inationary potential which would emerge if the momentary supply of capital values should fall back to normal. By any standard, the profusion of paper wealth constitutes the most enor mous single reservoir of inationary potential. Paper wealth is of several kinds but what we mean here is money wealth, which means debt. Paper property xed in terms of money amounted to $3.2 trillion in

1971

and

was increasing steadily. This was more than three times the gross national product and not far short of the total real national wealth of the United States. The number is fantastic. Paper wealth is not real wealth in any degree. Real wealth consists exclu sively of land, resources, productive plant, durable goods, and people. One class of paper property, such as titles to real estate, common stock owner ship of corporation assets, warehouse receipts for tangible goods, and the like, represents direct ownership of real wealth and therefore is functionally equivalent to real wealth. The paper property facilitates trading in the real assets, and no spurious increase in the apparent supply of capital values is possible. Money wealth works dierently. Money wealth is debt, and debt includes all forms of money contracts such as bonds, mortgages, debentures, notes, loans, deposits, life insurance, and pension obligations.

Debt does not

represent the direct ownership of any real assets, but it does represent a subdivision of interests in real assets with the direct owners of the assets. The superstructure of paper wealth is capable of subdividing the ownership of one set of underlying real assets into many layers of ownership of paper assets. For example, every man is a part of the real wealth but every man is sole owner of himself. Men as capital assets are not bought and sold, and no part of the money supply in capital markets is employed for this purpose. So long as a man thus remains sole owner of all his own productive output, he is not a part of the total supply of real capital assets purchase-able for money.

If he borrows money, however, he subdivides the ownership

103

19 Real Values of his future productive power with his lender, and they have created a paper asset which can be bought and sold. The borrower has subdivided ownership of himself, and he has added himself to the supply of capital assets. If he borrowed his money from a bank, and the bank borrowed its money from a depositor, still another layer of paper assets is based on the same fraction of one man's output. Subdivision and stratication of paper wealth proceeds to much greater lengths in the case of corporations through level after level of debt intermediation. Even government debt constitutes another layer of subdivision of the ownership of all of us by placing a lien on part of the productivity of all the citizens.

Through this subdivision

and stratication, the apparent supply of paper wealth can be increased to many times the real wealth. Obviously, the real wealth of a nation is not increased merely because the paper wealth is multiplied, but a moderation of ination occurs just as if it were. Paper wealth acts just as if it were real wealth. A nation's economy would have the same underlying real value with a small paper superstructure as with a large one, but the apparent supply of capital assets would be smaller and the permissible money supply must also be smaller.

Conversely, a large paper superstructure gives employment to

money supply in buying, selling, refunding, and reinvesting the paper assets fully as well as a supply of real assets would do.

The apparent supply

of capital assets is larger and the permissible money supply may also be larger. This immobilization of a monetary ination with an expansion of paper wealth may proceed to almost any extreme so long as the paper wealth retains its credibility.

So long as people do not doubt the paper

wealth, all is well. If people should doubt the paper wealth and decide to desert it, all becomes suddenly not well. If the money wealth is repudiated, the total supply of sale able real values drops by the amount of the money wealth, and prices of real values must rise correspondingly. As a practical matter, every advanced economic organization requires a considerable degree of complication of paper investment in order to function smoothly. In conditions of reasonable stability, the ratio of paper invest ment to real values would probably nd a minimum level of best eciency and remain there.

Ination, on the other hand, invariably stimulates a

tremendous expansion of paper wealth in relation to real wealth. Govern ment debt grows excessively, and private debt grows even more excessively. This colossal expansion of paper wealth is the most powerful single inu

104

ence for absorbing, moderating, and containing inationary force. On the other hand, the existence of this over-expanded paper wealth supplies, the principal compulsion upon the government to inate anew so as to erode the real value of the paper wealth continuously to manageable levels.

A

man who watches for inationary storms must keep a weather eye on the paper wealth. At every turn we have found pools, tanks, and reservoirs where the ac cumulated ination of the decades has been stored away without harm. Lagging money velocity has helped; price appreciation in capital markets has helped; spurious values in product and property have lent their aid. The most mammoth reservoir of all, the size of an ocean, is the unnatural and articial growth of the money wealth, and this is a factor which must remain in our minds throughout the remainder of our study.

105

19 Real Values

106

20 Government Debt Government debt does not dier in any respect from private debt or any other kind of money wealth. But since government debt and the budget decits which create government debt are constantly debated as having special importance to ination and economic well-being, they deserve some brief separate consideration.

The principal conclusion to be drawn from

that consideration is that they do not have such importance. The government budget decit was a bogey to orthodox conservatives and a magic talisman to Keynesian liberals for decades. In reality, it was as harmless but also as powerless as a pet cat. In the absence of its usual strong-armed accomplice, monetary ination, government decit invariably failed to work any magic. Monetary ination was always what did the job. Still the scal liberals clung undaunted to their beloved budget decits. The truth is that government debt, of itself, is not inationary. The cre ation of government debt through budget decit, of itself, is not ination ary. To the contrary, all of these, standing alone, are actually deationary. By "standing alone," we mean decits and debt which are not accompanied by an increase of the money supply. The basis for these strange allegations is that the issuance of government debt, like any increase in the paper wealth, increases the total supply of ostensible values available for purchase even though there is no increase in the underlying real values of the economy. So long as the paper wealth retains its credibility, an increase in the supply of paper values, just like real values, must reduce the equilibrium level of all prices. This is deationary. It may be that the only prices which will be deated are prices in the debt market, which is to say an increase of interest rates, but this is in every sense an overall price deation if no other prices go up to compensate. Open market operations of the Federal Reserve System work in precisely the same way.

In order to exert a tightening inuence on money and a

deating inuence on prices, the Federal Reserve sells government debt into the market. So too when the Treasury does it, and that is all there

107

20 Government Debt really is to a government decit. The government is free to incur any decit and issue any amount of debt it may wish, so long as it is willing to draw purchasing power away from other borrowers and to tolerate the rise in interest rates which will result. The debt will create no ination. Government decits and government debt thus are not inationary if they stand alone, but they never stand alone. The creation of government debt is practically always accompanied by an increase of money. Compet ing against private borrowers for a static supply of credit capital, a large government debt issue would drive interest rates upward, and high interest rates are anathema to a government. A large government debt issue sim ply could not be marketed without a large increase in the money supply. Therefore the government creates not only the debt but also the money with which to buy it.

In addition, large government decit expenditure

tends to accelerate the velocity of money because the government spends its money more rapidly than cautious private spenders do. This combina tion of increased quantity and velocity of money, not the decits, does the job, both for economic stimulation and for monetary ination. The combination of money quantity and velocity which practically always accompanies government debt is inationary, but less inationary than the money ination alone, without the debt, would be.

The presence of

the new government debt as an addition to the supply of values has a mitigating and therefore benecial eect.

If the monetary ination were

small enough to balance the new government debt just right (it seldom is), the net inationary eect could be zero. The same amount of money expansion without the new government debt would have been inationary. There was a good deal of specious validity to the argument made during World War II that huge budget decits and new government debt were positively necessary in order to soak up the inated money and purchasing power that the government was spewing out, assuming that the government really had to spew out all that inated money. The converse of this is that a government budget surplus, standing alone, is inationary. If the proceeds of a government surplus are used to reduce the total amount of government debt outstanding, the supply of values is reduced, the former holders of the debt still have the same purchasing power to use elsewhere, and the equilibrium level of prices must rise. In the same way, when the Federal Reserve System wishes to provide easy money and inationary conditions, it buys government debt in the open market

108

and substitutes money for part of the supply of values. So too when the Treasury does it. Of course, if the government should not use its surplus to reduce its debt but instead should simply hold the money immobilized, eective money supply would be reduced and the surplus would not be inationary. To avoid the inherently inationary eects of a surplus, the government must do this, but it seldom does. Any reduction of government debt which is not accompanied by a reduction of money quantity or velocity is inationary. Any resort to a government surplus to ght ination is worse than futile, it produces the opposite of its intended result. The only limit to the ination-absorptive eect of government debt, like any money wealth, is the credibility of the debt. As long as the government can sell its debt, it can use debt to restrain the inationary eects of its high-velocity spending and its money creation. Only if all trust in money wealth is lost through ination is the restraining capacity of government debt lost. At that point, and only then, does government debt shift from a dampener to a fuel of ination. Existing money which has been employed in debt markets leaves them for other markets, inating prices there, and the government debt itself represents an obligation of the government to issue additional money in its place at maturity. Government debt which holds down ination while the debt is credible amplies and re-amplies ination when its credibility fails. That failure is the sole inationary potential of government debt and the sole risk of running government decits. Short of that, government debt does good work.

109

20 Government Debt

110

21 The Record Interpreted Holding our freshly calibrated ination tape measure in hand, we can now clamber over the historical record which ination has left us in America and Germany and elsewhere and take some measurements for our edication. This tape measure is unfortunately not yet a magic monitor for ination. Even with its aid we have diculty estimating future ination. The reason is that two of the three variables which enter into our measurements, money velocity and the supply of values, are quite dicult to determine. Velocity is bad enough but the supply of values, as explored in the preceding chapters, is so complex as to be impossible. The tape measure works, but as to any current state of aairs our ability to isolate the components to be measured remains rudimentary. With respect to past ination, the diculty is not so great. If there was ination, we know that the quantity of money was too great, and also how much too great. From that knowledge and knowledge of what the quantity of money actually was doing, we can deduce what the other variables must have been doing. From this analysis of the past, we can form some useful hypotheses about what is happening in the present. From stability in

1939

to stability in

increased enormously but only about

60

1948,

prices in the United States

percent as much as money supply

did. The same relationship existed in Germany of World War I, although the actual magnitudes of increase of both prices and money supply were much larger. The only possible explanations of why prices did not increase even more than they did, correlating more closely with the money supply, are that velocity decreased or the supply of values increased. there was a little of the former and a great deal of the latter.

Probably Velocity

in the United States declined steeply during the war and turned upward after the war, but by

1948

still was not as high as before the war. A mod

erate decrease of velocity therefore helped somewhat to abate the money ination.

A rise in the supply of values, absorbing the remainder of the

gap between money increases and price increases, can only be inferred but

111

21 The Record Interpreted is easily reconciled with the facts we do know.

The wartime increase of

American productive capacity, even after eliminating purely military pro duction, was large.

The increase of government debt as a new addition

to the supply of values was even larger. Because of all these factors, the inationary potential at the end of the war was not as great as the money quantity ination alone. Any person who at the end of the war thought that ination had been safely contained was wrong, but any person who thought that equilibrium prices were as much higher as money supply had already ascended was equally wrong.

The unrealized depreciation of the

dollar was something less than the money supply alone seemed to dictate. By contrast, the salient feature of the record after the stabilization of

1948

was the much closer correspondence of prices and money supply at

points of equilibrium. The principal points of equilibrium, which means the points at which money supply and prices were stable and in equilibrium with each other, may be taken to be late

1949, late 1953, and late 1962.

The

absence at these points of either upward or downward tendency of money or prices was the mark of stability. From each of these points of stability to the next, the percentage rise in prices was in a constant relationship to the percentage rise in money supply: price ination from stability to stability matched the money ination, to the fraction of a percentage point, to the extent that money expansion exceeded something like seven-tenths of one percent per year.

Whenever prices and money were out of that relation

to each other, there was disequilibrium and either upward or downward pressure on prices until they were forced back into that relation. The quantity theory of money in its simplest form would suggest that prices might move in direct proportion to money supply in this way. We know that the theory in this form is too simple and not always true, be cause velocity and the supply of values are as important to prices as money quantity, but it happened that the simple direct relationship between equi librium prices and money supply very nearly held good in the United States for fteen years. This must have meant that the increase in the supply of real values during that time was approximately equal to the increase in the velocity of money, and that the two thus canceled each other out. This is not implausible.

The imperfect evidence that we have seems to indicate

an average increase of velocity of at least

4.8

percent per year during this

time, while the average annual growth in gross national product in constant dollars was something less than

112

4

percent per year.

If equilibrium prices were indeed in this constant relationship with money supply, the only money supply which could have avoided all ination would have been a money supply that increased at a rate of no more than

0.7 per

cent per year. Furthermore, so long as this parity held good the unrealized depreciation of the dollar could be estimated between points of stability while an inationary episode was in progress. The amount of latent ina tion yet to be endured to the next point of stability could be estimated with some degree of condence. The Index of Latent Ination at any given time was the further percentage rise of prices which was necessary to put prices back in equilibrium with the expansion of money that had already occurred since the last point of stability.

This kind of estimation would

have proved itself precisely correct at any moment during the years from

1948

to

1962.

If this index would have correctly estimated latent ination at all times

1962, perhaps it might also do so after 1962, and nothing that had oc curred through 1973 indicated that equilibrium prices and money quantity before

were in other than the same relationship. As applied to the great ination ary upsurge that began in

1962,

the Index of Latent Ination showed an

almost constant increase from zero at its base point of stability, in Septem ber

1962,

to more than

administration in

1968.

18

percent by the close of President Johnson's

It exceeded

22

percent by the end of

1972

under

President Nixon. Never since the end of World War II had the assured but hidden depreciation of the dollar been permitted to grow so large. If the experience of those decades still applied, equilibrium would return and the ination be ended when and only when price ination was allowed to race ahead to catch past money ination, without any new money ination and also without any of the concomitant pleasures of money ination. These relationships cannot be taken as immutable, nor these temporarily accurate laws as holy writ.

Guessing the unrealized depreciation of the

dollar and the equilibrium level of prices was still as chancy as it had been at the end of World War II. If the apparent supply of values really contained much false value that would be sloughed o upon a return of stability, equilibrium prices might be considerably higher than the index would predict. On the other hand, a return of stability might very well halt the rise of velocity or even lower it, and in that event equilibrium prices might not rise as high as predicted.

Until some better evidence oered

itself, however, the Index of Latent Ination based on the relative increases

113

21 The Record Interpreted of money supply and prices since stability in

1962

seemed the best guess

anyone could make. It should be reassuring, if anything, to understand that ination is not interminable and inationary potential is not innite. A further ination of

20 percent or so was not, after all, unthinkable. It was much less than 50 percent latent ination that existed at the close of World War II,

the

although it was also much more than the peak latent ination of only about

4.5

percent at the worst of the

1956

ination.

Knowing the nitude of

inationary potential can go a long way toward removing its terrors. One of the interesting comparisons between the German ination and other inations, however, was not how large was the unrealized depreciation of the Reichsmark in that worst of all inations but exactly the opposite, how really close to equilibrium even Germany was at all times while it destroyed itself. At the very peak in

1921,

money supply had. only about

doubled while prices had not yet risen. The latent ination of the mark was therefore probably never above

100

percent after the

1920

stability. If

Germany had merely accepted another doubling of its prices and stopped inating its money, it could undoubtedly have ended the ination with no more pain than it ultimately had to suer in

1923

and

1924.

A worse

inationary potential than this had been cleanly liquidated immediately after the war by Erzberger's nancial policies of 1919. But Germany in 1922 was incapable of submitting voluntarily to any pain whatever, so that instead of ending the ination it gave chase to it. That ;was what spelled the dierence.

114

22 Money Let us pause for a brief digression or two on some conceptual matters that have importance to comprehending the economic riddle.

The rst

digression is the proper conception of the thing called money. Earlier we said that money's proper use was as a medium of exchange, that money doing its duty was money in motion. Later we saw that money combined with its rate of velocity was the opposite side of a balanced equation from the total supply of real values of all kinds.

Money was

the counterweight to all things of value, money was the opposite of value. Money's value is purely derivative; money has no value of its own. Money is a reector of the economy it serves. The entire economy is the backing of the currency; more properly it is the "fronting" of the currency, because money and all things of value confront one another, they do not stand behind one another confronting something else.

A unit of money is like

a share in the entire economy it serves, and inating the money is like diluting the shares. No partial supply of gold or any other thing of intrinsic value is the true backing of a currency or has anything to do with the value of currency. Types of money like gold, which do have an inherent value other than as a medium of exchange, cannot do otherwise than obstruct the proper management of money. Gold was always best as money for the very reason that it came closest, after valueless paper, to having no non-monetary value, while at the same time being limited in quantity and scarce.

Gold did

therefore have a certain disciplinary quality, but the correlation between the actual supply of gold and the proper supply of money at any time, if there was any correlation, was always purely coincidental.

A properly

managed at currency, frankly having no inherent value even imaginary, is innitely superior as money to gold or any other commodity having a conicting real value. One of Karl Helerich's more striking exercises in scholasticism, reminis cent of how many angels can dance on the head of a pin, was his extended

115

22 Money theorization of whether money was a thing of value in itself. His arguments were ingenious, persuasive, and wrong. He said that it did. It does not. Money, being derivative of value, reective of value, a reciprocal to every thing else of value, is a kind of anti-value. The more vigorously people seek to use money, the more it should disappear. If they use money with perfect eciency, there should be no money. Where then did the value go? When a money supply does exist, implicitly because of a degree of ineciency in the use of money, that money supply is a quantity having no inherent value. Money may appear to be, and is, something of value to any one member of an economy because it represents a valid general claim by him against all the other members; but to the economy as a whole all of these claims against one another are canceled out leaving money an absolute cipher in the real value of the economy. This is not an exercise in scholasticism equal though opposite to Helf ferich's. Because of the rigorously vacuous nature of money, we do well to look through the money level of all economic ows, as through a window, and see instead the underlying ows of real values among the members of an economy.

If we succeed in doing this, we go far toward shedding

the misconceptions of economic management which a preoccupation with money may cause. For example, if I buy a car with money which I earned by operating a machine, I am really trading some of my machine-operating services to the man who sold me the car. If he did not happen to want any of my services, I gave him a negotiable receipt  money  from another man who did.

Money is but a unit of notation among three parties 

myself, the man I sell my values to, and the man I buy my needs from. Barter trading involves only two parties and money trading involves three, but in either case the true subject matter of the trading is the ow of real values among the parties and not the paper receipts. To the economic system as a whole, money is even more militantly neu tral. The real value of an economy is its people, land, capital assets and natural resources. Real value is the same whether the system has only a simple paper superstructure consisting of little money and few debts, or a huge superstructure of much money and many levels of paper investment. Neither form of organization is richer than the other, except for the waste implicit in any organization which is unnecessarily complex for its purposes. Increases of real wealth can only be achieved by luckily discovering new nat ural resources, or by strokes of genius resulting in technological discovery,

116

or by working harder, in no other way, and most certainly not by creating money. All of this is relatively obvious and relatively elementary, but it is not al ways remembered. Economists, politicians, and plain people are constantly harping on money as if the money itself mattered. A person is spoken of as "having money" when he does not really have large cash balances at all, but non-monetary real assets which can be converted into money and then into some other real assets more or less at will. A government is spoken of as "nding the money" for some national objective, such as housing, instead of another, such as war, when it really seeks to divert resources out of one activity, choking o that activity and destroying investment and employment in it, and reapplying them to another. Money means nothing to any of this. Money is merely the hypodermic instrument by which the lifeblood is drained out of one economic body and injected into another. "Having money" or "nding money" is metaphorical, but its metaphorical nature seems constantly to be forgotten, deluding people in the subtlest of ways into thinking that money is the problem. Money is a monumental nothingness.

Creating money cannot create

real value, and destroying money cannot destroy real value. Real wealth does not rise if the money world booms, nor does it diminish if the money world falls apart.

The real world is too real and the money world too

evanescent. To use money as a positive instrument for real well-being is to use a vapor for a hammer. All that money manipulation can do is to alter the direction of ow of real values and to alter the distribution of real values among the members of the economy. Money manipulation is of course not the only way to redistribute wealth, but redistribution of wealth is the only way that money manipulation can work. If money manipulation increases wealth anywhere, real assets must be taken from somewhere else. What we seek to do is to look through the money ows and to see where the real wealth we have apparently gained actually came from.

117

22 Money

118

23 The Creation of Money The second digression is on the subject of the creation of money.

Since

money quantity is the controllable variable, creation or destruction of money is the mechanism for managing a currency to exclude ination. Some rather strange goings-on happen in the dark little room of the eco nomic house where money is created or destroyed. Money management consists of creating money to match exactly any increase of the supply of values, and to oset exactly any decrease of money velocity.

Monetary ination consists of allowing any greater quantity of

money than this to exist, and monetary deation any smaller quantity. In principle, it should be possible to set up a computer readout on the desk of the Chairman of the Federal Reserve Board to indicate the intrinsic value of the dollar from minute to minute, and his organization could then add or subtract money to hold the indicator steady. In practice, the raw statistical data for the computer are so fragmentary that this is not possible. Money management is less a matter of information conversion than of instinct. The government's tools of economic management divide into two parts, monetary policy and scal policy. Monetary policy means manipulating the money, and the Federal Reserve System has charge of this. Fiscal policy means manipulating the taxes and expenditures of the government, and the Treasury Department has charge of this. The government's economic responsibility is a deeply divided responsibility.

In this chapter we are

speaking of monetary policy and the Federal Reserve System. If money has the principal function of a medium of exchange and the in cidental functions of a store of value and a standard of value, then money also has the principal duty of having a constant value. The proper business of the Federal Reserve as guardian of the money is to provide it a constant value. The United States would take a long stride forward if the Federal Re serve would do no more than guratively to set up that computer readout on the desk of its chairman and bend all its eorts to holding the indica tor steady. Professor Milton Friedman, chief critic of the Federal Reserve,

119

23 The Creation of Money made this point repeatedly, and it is dicult to add much to his arguments. Never in its entire history had the Federal Reserve taken as its sole duty the stabilization of the value of the dollar. Instead it meddled with controlling interest rates, nancing the government, producing economic growth, pro viding jobs, dampening booms, and reversing recessions. All of these may well be the business of the government, but not of the money guardians. On the other hand we sometimes found the Treasury Department trying to stop ination, which is not its business either. If the Federal Reserve would narrow its focus to achieving constant prices and thereby remove all the purely monetary causes of economic ill health, like ination, it would do all that was required of it and far more good than monetary policy had ever achieved before. This task, while denable, was not easy.

The Federal Reserve knew

reasonably well what the money supply was, but that was all that it knew reasonably well.

Its information about velocity, about the relative use

of money in capital and product markets, and about the supplies of real values in all markets were all poor.

Monetary policy, in short, needed

much greater familiarity with its own job and much less concern with other jurisdictions of economic management.

In the end, the task might turn

out to be a little easier than it seemed. In stable conditions, if they should ever be established, all the variable factors might maintain a fairly constant relationship to one another. If so, the Federal Reserve would not need so desperately to know each of the component variables. The better monetary policy did its proper job, if it ever did, the easier it might be to continue doing it. Once the monetary authority were persuaded to conne itself to control ling the money, it would nd that its control of the money was none too rm either. This was principally because of that remarkable feature of the money system known as fractional-reserve banking. Most of the money in the United States, as in other countries, was not created by the govern ment at all but by private banks. Only about one-third of all money was government money the way a dollar bill is. All money consists of currency, like dollar bills and coins, and checking account deposits with commercial banks. The quantity of checking account deposits in the United States was almost four times as large as the quantity of dollar bills and coins. All of the dollar bills and coins were issued by the government, and they were government money. In addition, the commercial

120

banks had reserve deposits with the Federal Reserve, and these reserve deposits too were obligations of the government and therefore government money. The rest of the checking-account money was not. The total of all the dollar bills and all the Federal Reserve deposits, constituting all the government money in the country, was only one-third as large as the total money supply.

The reason for this was that the banks' reserve deposits

with the Federal Reserve equaled only a small fraction of the deposit money which the banks created. The reserve requirement was set by the Federal Reserve Board and was mostly around

17 percent in the 1960's.

The result

of this extraordinary system was that two-thirds of the money supply was no more true money, like a dollar bill, than the promissory note of your friendly banker, or, for that matter, of your corner druggist. If everyone demanded this part of his "money" in dollar bills or other government money, he could not get it because it did not exist.

It functioned like

money but it was not money. The economic eects of this kind of system were astounding. The most breathtaking was the awesome gift which it made to bankers. The power to create money was obviously a lucrative one. Whenever the Federal Re serve increased the money supply, it created only the reserve portion and the banks created the larger remainder. For every dollar of new reserves issued by the government, banks were permitted to create four or ve ad ditional dollars out of thin air and lend them out at interest. This subsidy to banks is especially spectacular in inationary times when money is be ing voluminously created.

Lord Keynes exclaimed his incredulity of the

phenomenon in Germany, by which the Reichsbank did not even reserve a monopoly of money ination but let the private banks share.

In the

1972

to June

United States, in the single twelvemonth period from June

1973,

the banks were allowed to create over thirteen billion dollars more

than the government did.

By giving away this much of the money cre

ation privilege, the government gave away to the banks more than twice the entire expensive farm subsidy programs, about half its extremely large budget decit, and more than one-fourth the entire growth of the real na tional product for the same one-year period. Farming out the government's money creation rights to commercial banks had many of the characteristics of the infamous tax-farming systems of history, by which the tax farmers made fortunes and the governments realized precious little revenue. It goes without saying that this system contributed mightily to the overowing

121

23 The Creation of Money prots of the commercial banks during the money ination of the

1960's

and helped explain why plush new sky-scraping bank buildings were one of the more conspicuous forms of growth of that period. Fractional-reserve money has other even more destructive eects. The government's control of the money supply is weakened by it.

Bankers

and people in general can cause the money supply to increase or decrease in direct opposition to the Federal Reserve's eorts to manage it. If the Federal Reserve increases reserves, still no increase in the money supply will occur if the banks will not create the money and lend it out.

This

may cause what is known as a "liquidity trap." Conversely, if the Federal Reserve tightens reserves the banks may still increase the money supply by borrowing reserves from the central bank. If people for no conscious reason shift one net dollar from paper money into checking accounts, four or ve more dollars of checking accounts may spring into existence because of the reserve multiplier without any desire by the Federal Reserve that money expand. Conversely, for every net withdrawal of one dollar from checking accounts into paper money, the bankers must destroy four or ve more dollars of checking accounts regardless of the will of the Federal Reserve. Precisely this wholesale destruction of money in the

1930's,

caused by a

ight into paper money compounded by the reserve multiplier, underlay the banking crises of those years and the great depression itself. The fractional-reserve system potentially can contribute fully as much mischief to disastrous ination as it did to the great depression. If govern ment debt should lose its credibility so that the government was compelled to substitute money for debt, the ultimate ination of the money supply would not merely equal the replaced debt but might actually be four or ve times greater because of the banks' powers to create additional money on the new reserves. Milton Friedman attributed the nation's severe ination of World War II directly to the fractional-reserve system, hampering the Federal Reserve's control of money supply, and not to any basic defect in the nation's overall strategy for nancing the war. Any intelligent novice, rst introduced to the workings of the money system, must nd the pyramiding of money on the fractional-reserve base incredible.

A few of the nation's foremost economists, led by Henry C.

Simons and Irving Fisher, were of the same mind at the depth of the depression when they urgently advocated abolishing the system. The idea was simply to require

122

100 percent reserves for all checking account deposits,

so that all true money was government money.

Instituting that system

would have been little more than a bookkeeping entry, but after it was done all the evils of the fractional-reserve system would disappear.

The

idea was called the only fundamentally creative idea to come out of the depression. But the idea passed into limbo. The best economic minds were in favor of it, but the commercial bankers could be counted on to resist to the bitter end the loss of their money machine, and the people and the legislators probably did not understand what it was all about. Little was heard of the idea in later decades except occasional, and rather inaudible, reminders by a few economists. This complacency would no doubt persist until still another series of disasters came to pass with the substantial aid and comfort of the fractional-reserve system. If all money is to be true money, no one can be permitted to create or destroy money except the government. Each citizen who thinks he owns a dollar of real money should own not

15

or

20

100

cents of claim on the government and

cents. The government, when it wishes to expand or contract

money, should simply add or subtract that many dollars and not have to add or subtract only a fraction as many as reserves, waiting for banks and people to do the rest. Above all, no one should enjoy the incidental benets of money creation but the government, using these benets for its public purposes. As these things stood in the United States, when money was to expand, the Federal Reserve must buy up debt obligations (supporting that market) to create reserves, and banks multiplied the reserves into money.

If the

government needed the money, it must go into the same markets to borrow it and pay interest for its own money.

There was a wall between the

Federal Reserve and the Treasury. Conversely, when money was to tighten, the Federal Reserve must sell debt obligations (depressing that market) to destroy reserves and banks must call in loans to destroy additional money, further depressing the credit market. Meanwhile the Treasury taxed and spent, blithely unconcerned with what the Federal Reserve was trying to do. Again there was a wall between Federal Reserve and Treasury. There was a reason for the wall, to be sure, and the reason was a good one. The reason was nothing less than a frank, healthy, and fundamental distrust of political governments. The Federal Reserve was independent in the hope of avoiding the ination which, it was thought, would inevitably follow if the insatiable exchequer had access to the money machine. But the

123

23 The Creation of Money independence was a ction, and the hope was either futile or superuous. Whether or not there was unication in form, the Federal Reserve and the Treasury must know how to speak to one another and to act like a right hand and a left of the same government. And they did. The Federal Reserve inated when the government wished to inate, as in the Kennedy-Johnson years; and held back when the government wished not to inate, as in the Eisenhower years. The arrangement was no more inationary than if the Federal Reserve were truly independent, and no less inationary than if it were unied with the government. The form did not matter, only the substance. This being so, money should be placed at the disposal of the government and vice versa. Whenever sound money management calls for new money  and normally it will call for a small amount of new money continuously in a stable, growing economy  the money should simply be issued to the government, interest-free, for spending on its public purposes. The rst use should always be the government's and without any connection to credit markets.

By the same token, whenever sound money management calls

for an actual contraction of money  it seldom will  the huge taxing powers of the government should be at the service of money management. So much of tax revenue should simply be taken, immobilized, and not spent, again without any connection to the credit market.

Bankers and

private holders of debt should be neither beneted nor harmed when the government expands or contracts money. These ideals of money management are many leagues away from the way money management worked in the American ination. Change comes slowly; there was no perceptible improvement in these aairs in the entire twentieth century.

Real progress usually is borne only of crisis at best,

disaster at worst, and the opportunity to wring real progress out of the depression disaster was missed. It could only be hoped that there might still come either timely change or a superhuman ability of money management to overcome its own self-imposed disabilities.

124

24 Depression We have now thoroughly mastered the problem of ination. This may come as something of a surprise, but it is true. Properly understood, ination is not really much of a problem at all. The problem of ination is not widely understood properly, either, but that too is only one of the miscellaneous problems. Unfortunately, however, ination is not the only major problem nor even the paramount one.

Having mastered that one, we have still

scarcely begun the battle. The other side of the problem is depression. The problem of depression goes under many names and can be thought of in many ways  recession, the business cycle, the boom and bust of capitalism, secular stagnation, and above all unemployment  but all boil down to the same thing, which is depression.

For a precisely imprecise description of this problem, we

might call it a chronically insucient prosperity for the people as a whole. How much prosperity is sucient, and how little is insucient, is a nice question.

There can never be so much prosperity that there could not

be more, or so little that there could not be less.

Mankind can always

bring himself to accept more prosperity and usually could put up with less. For an answer to how much prosperity is "sucient," we might adapt Lord Keynes' excellent denition of involuntary unemployment: sucient prosperity exists when the people would not be interested in obtaining any more prosperity at the cost that would entail in harder work or greater expenditure of resources.

Insucient prosperity exists when the people

would be interested in more prosperity, even at the expense of harder work, but are held back by some articial restraint from doing what they are willing to do. Sucient prosperity is not an absolute, related to quantity of production, but relative, deriving from the people's inclinations. Sucient prosperity is a natural level at which people are freed to have just as much as they care to work for. According to this denition, prosperity which is lower than the theoretical maximum may still be "sucient" by the lights of the people. Nevertheless, I accept the premise of activist economics that

125

24 Depression insucient prosperity was a chronic problem of the United States in recent decades. It has been a reversal of the usual order of precedence for us to study ination before depression and to place price stability before prosperity. Economists have habitually been more deeply concerned with depression and unemployment than with price ination. must agree.

With this priority too, we

Adequate prosperity is more important than an absence of

ination. If there is a necessary conict between stability of prices and a reasonably fruitful economy, stability of prices must yield. The proposition of this book is that there is no such conict. Even accepting the priority of prosperity over price stability, we were right to address the lesser mat ter of price stability rst.

If the requirements for price stability are set

up rst, not last, then the means to prosperity can be found and tested which do not violate these requirements. If on the other hand prosperity alone is set up as a goal and prices are left to lodge where they May, as all modern economics did, the result is a fatalistic acquiescence in ination. Economists oer the easy but false apology that ination is the inevitable price of prosperity. Admittedly, demanding not only sucient prosperity but also price stability makes the task of economic management more dif cult than demanding prosperity alone. Economists would prefer to have the easier task. This is why it is perilous to let economists prescribe the specications for their own performance. Professor Milton Friedman of the University of Chicago was the leader of a school of economics, popularly called "monetarists" or the "Chicago school," which averred that regulation of the quantity of money controlled not only ination but also the suciency of prosperity.

Professor Fried

man's epic work produced with Mrs. Anna Schwartz, A Monetary History of the United States, traced in minute detail from the Civil War to

1960

the correlation of money supply changes with the boom/depression cycle as well as with price inations and deations. The evidence was exhaustive and irrefutable. Monetary constriction preceded every major or minor de pression, recession, rolling readjustment, pause, or other popular name for insucient prosperity. an ination.

Every monetary expansion preceded a boom and

Extreme monetary contraction as the cause of the extreme

severity of the Great Depression was especially striking. Similar principles operated on the economic course of the United States after World War II, when each money expansion was followed in order by stock market boom,

126

rising business and employment, and price ination; and each money non- expansion by stock market fall, insucient prosperity and unemployment, and price stabilization. Professor Friedman concluded from all this convincing evidence that ex pansion and contraction of money had been a principal contributing cause to economic instability. Eorts by monetary policy to oset the economic cycles worsened the cycles.

To avoid that, Professor Friedman proposed

that money expansions and contractions be stopped and replaced by a steady rate of money growth. Any rate of change, if steady, said he, would be less damaging than expansions and contractions were.

Beyond that,

Professor Friedman's ultimate conclusion was that if money policy simply stopped changing, stopped upsetting the economy, and adopted a steady, non-inationary growth rate, sucient prosperity would take care of itself. In the truth or falsity of this proposition lay the acid test of the straight monetarist economics. This book's extremely high regard for Professor Friedman's economics in general must have become obvious before now. Most of the sense that was uttered in English-speaking economics after Lord Keynes was uttered by Milton Friedman or that small coterie he represented. Professor Friedman was one of the few true prophets around, a more minor one than Keynes himself perhaps but at least a true one. Professor Friedman was no more totally immune from error than Keynes himself, but he carried a rich freight of validity in most that he said. He was right that money causes inations, that money causes depressions, and that money cycles cause instability that a steady trend would avoid. But when he reached the ultimate conclusion that sucient prosperity would take care of itself without ination if money growth were only steadied, I fear he was wrong. The evidence, though less abundant, was to the contrary. Professor Friedman's original proposal was for a money growth of

3

to

5

percent per year. Unfortunately this was the proposal that became lodged in the heads of the uncomprehending and was bandied about in pseudo- monetarist thinking of the

1969-1973 stage of ination.

By all the evidence

since World War II, this amount of money growth would also establish a

5 percent per year. The best example is the money growth that began in 1954 and produced the ina tion of 1956 and was somewhat less than 4 percent per year. Later and steady rate of price ination of about

3

to

much less noticed, Professor Friedman changed his mind and said that the

127

24 Depression right money growth to avoid ination should be only

1

or

2

percent per

year. This was closer to the truth. Unfortunately, however, every postwar period in which money grew by no more than i percent per year, notably

1954

itself, still produced clear-cut recession, insucient prosperity, and

unemployment. With regret we must admit that Doctor Friedman's prescription, though entirely correct, would not be entirely eective. Monetarism alone would not do the job. Stabilization of money alone would not solve all the prob lems. It remained possible to have both sucient prosperity and an absence of ination, but it was not possible without other structural adjustments to the economic organization besides sound money.

128

25 The Economics of Keynes The English economist John Maynard Keynes single-handedly built the twentieth century's economic milestone in

1936 when he published his work,

The General Theory of Employment, Interest, and Money. It is if anything an understatement to describe the eect of this work as a Keynesian revo lution. It is impossible to speak of matters economic after the appearance of this work without dealing primarily with Keynes. Its inuence on apos tles and skeptics alike was so profound that it was truly said, as Milton Friedman did say: we are all Keynesians today. Keynesian economics were at the bottom of all the economic problems that scourged the United States and the world as the

1970's

began, but

nothing in this book is intended as a general attack on either Keynes or his General Theory. Quite the contrary. Keynes is an acknowledged master, or at least this book acknowledges him as master. If Milton Friedman was a true prophet, Keynes was not only a true one but the major prophet of the century in economics. This book is indeed Keynesian in the deepest sense, what might be called proto-Keynesian rather than neo-Keynesian. The work of Keynes himself is to be clearly distinguished from that of his disciples; that is why this chapter is entitled not

Keynesian Economics.

The Economics of Keynes

and

The latter name might better be applied to the

next chapter, which is otherwise called

Inationary Economics.

Almost

every true prophet's teaching tends to be perverted by his disciples, and blessed is he that has no disciples. Keynesians earned an undeservedly bad name for Keynes himself. Modern Keynesian economics were scarcely more true to Keynes than the Spanish Inquisition was truly Christian. Keynes wrote many books, not just the General Theory. A number of them are quoted at various places in this book.

Reading Keynes' work

conveys more of the sense of a profound intellect at large, testing the cir cumstances with real understanding, than the work of any successor. To learn from Keynes, one does best to skip the Keynesians and go to Keynes himself. Keynes was not free from error; he was superior but not superhu

129

25 The Economics of Keynes man. Most of what he said was valid when he said it, and some of his most revolutionary thoughts were also valid for all times. The modern problem is to select and build upon the more timeless of Keynes' building blocks and not, as Keynesians did, on foundation blocks which were sound only in special circumstances like the Great Depression. One of Keynes' most interesting and exible traits was his habit of changing his mind from one book to the next. He began each later book by discarding some of the basic ideas of the preceding one. He also was a great one for confronting present problems presently and putting to one side problems that did not yet exist though they might exist later. Specically that was how he freed himself from concern about ination during the depression when the General The ory emerged. A decade earlier, when ination raged through Europe, he had been an equally incisive student and critic of inationary economics. Keynes died just after World War II, and in his last conversations with friends was already reacting against the Keynesians.

One entertains no

doubt whatever that his General Theory would have undergone wholesale alteration in his later books if there had been any, just as his earlier works had done.

The General Theory was simply Keynes' last word when the

bell rang. The General Theory, despite its title, was preeminently a product of its time, which is to say a product of the worldwide Great Depression of the

1930's.

Keynes spoke from a time when great numbers of people who

wanted to work could not nd work to do, when productive plants were idle for lack of buyers of their products while the potential buyers also were in want of the products, when money had been allowed to disappear and the people would not spend what little money there was. There was exces sive saving, under consumption, underinvestment, and underemployment of people and capital. There was acutely insucient prosperity. To Keynes or to any economist or layman, this situation made no sense at all. To any reasonably keen instinct it was plain that all the makings of economic pros perity were present. In terms of real potential nothing had changed from the

1920's,

and therefore miraculous re-improvement of economic health

could be wrought if someone could only nd the key to make things start turning over again. All of this instinct was absolutely sound. Keynes applied himself to this problem with a typical readiness to inno vate. He cast aside the orthodox economic learning which had accumulated over past centuries, and he built a structure of thought from the ground

130

up which incorporated some audacious new conclusions:

1.

The state must intervene; sucient prosperity would not take care of itself if laissez faire economics left it alone;

2.

The body economic must be forced to consume more, thereby spend ing itself rich, and not try to save so much;

3.

Consumption is stimulated by jobs, jobs by new capital investment, and investment by the state's creating articially low interest rates on capital rather than high rates as the classical economics said;

4.

Where necessary, the state should deliberately spend more than it taxes in order to stimulate investment, business activity, and con sumption.

This reasoning contained the germs of all that later became the Keyne sian economics:

government management, full employment, low interest

and cheap money, deliberate government decits, investment, consump tion, economic activity, and growth. In the circumstances of the depression, Keynes placed prosperity before price stability in importance with a vengeance.

His treatment of prices

and ination in the General Theory came last and weakly. His pragmatic strategy was to solve the depression rst and worry about ination later if it should become a problem later.

In the abnormal circumstances of

the depression, his trust in the work of his predecessors and himself in the quantity theory of money grew faint. He was content to say that as long as resources of people and capital were idle  in other words, as long as there was a depression  economic stimulation according to his suggestions should not cause ination. When that was no longer true, he said, there might be a problem. There might indeed. Keynes' propositions amounted to nothing more or less than a prescrip tion of simple monetary ination.

This point might be disputed, but it

is essential to following Keynes' policies to their sources. monetarist at heart.

Keynes was a

Through all of his intricate technical reasoning, a

single precept shone forth: monetary ination has marvelously stimulative short-term eects. Governments have been rediscovering this with delight throughout the ages by instinct, but Keynes clothed it in an aura of the recondite that made it seem wonderfully new and magical. It was still the

131

25 The Economics of Keynes faithful old home remedy of monetary ination.

Low interest rates and

abundantly available money, which were a part of Keynes' prescription, were obviously a function of expanded money quantity. Less obvious but still true, government budget decits also operated through accompanying monetary expansion, either by increasing the supply of money or by accel erating the velocity of existing money. As we have seen, without money ination government decits would cause nothing but higher interest rates and deation. Monetary expansion was therefore Keynes' fundamental op erative agent. To say that Keynes' prescription was monetary ination is not to say that it was an invalid prescription. Monetary ination is a legitimate tool of economic management.

It has some good eects and some bad ones.

Instead of being taken as a matter of emotion, monetary ination should be evaluated dispassionately like any medicine for its good eects and bad eects in particular circumstances. This medicine is proper when its good eects will do more good than its bad ones harm, or when its bad eects will be no worse than the existing state of aairs. Like a dose of cocaine, one calls for ination when the situation demands, but not usually for a mild tummy-ache. Keynes' years of the Great Depression were as apt a time for a prescrip tion of monetary ination as there ever was. To begin with, this depression was caused by an extreme monetary deation. Money quantity and velocity each contracted by one-third by

1932,

which meant that aggregate money

demand as the product of the two was less than half its original level. Some of this contraction showed up in lowered prices, but the remainder showed up in reduced business activity and supply of values.

Both eects were

unqualiedly vicious. If at any time the government had eectively coun teracted these contracting trends, the depression could have been stopped from worsening. Massive monetary expansion by any of the Keynesian de vices could have done this without ination. Issuing and spending sucient money to keep the quantity of money from decreasing is an obvious one. If the people's hoarding of money causes a one-third reduction of velocity, the government can issue and spend ination.

50

percent more money quantity without

If banks have lots of money supply to lend, but people refuse

to borrow causing low velocity and low interest rates, the government can step in and borrow the money to spend by means of budget decits with out causing either excessive interest rates or price ination.

132

All of these

propositions of Keynes were sound propositions in the Great Depression, and within the limits of the price equation none would have caused price in ation. In reality they would have constituted only monetary stabilization and not monetary ination at all. The true test of Keynes' General Theory comes later, after the deteri oration of the depression has been halted.

By

1936

when his book was

published, the contraction had been over for several years and a new equi librium had been reached, but the equilibrium was one of plainly insucient prosperity. Money quantity and velocity were no longer decreasing or in creasing, and there was no deation or ination. But velocity stayed low, interest rates stayed low, everyone lived more frugally than he formerly did, buying less and saving more and watching his money, and as a consequence many people and factories could not get as much work to do as they for merly did and would like to do again. This abnormally low consumption was mostly a psychological scar left over from the bueting of the earlier contraction, and not a chronic condition of capitalist economy, but still it existed and called for remedy. Here too, confronted by this acid test, it is possible that Keynes' prescrip tion of monetary ination might work without price ination. Monetary ination always has short-term stimulative eects, and in these depressed conditions the stimulus might very well cause the supply of saleable values to increase by fully as much as the monetary ination. If so, there would be no price ination. Remember that price ination is by far the slowest of all the eects of monetary ination. Economic stimulation comes rst. In one of his earlier books Keynes made the famous quip, "In the long run we are all dead," by way of admitting that price ination follows money ination but not right away. In the meantime, other things may happen to forestall the price ination. Fundamentally, what may happen is an increase of the supply of values. Throughout the

1930's,

the supply of real values available for sale and

which could be sold was much lower than it had been in the

1920's.

The

supply could easily be increased, but the increased supply could not be sold. This was because of under-consumption; some people were unemployed and had nothing to buy with, and others who had some money saved it.

If

monetary stimulation by the government could put people back to work and give them the means to buy, the saleable supply of values would grow to meet these new means and put still more factories and people back

133

25 The Economics of Keynes to work.

In the light of the proved ability of the nation to produce and

consume as much as in the

1920's,

all of this, magical as it seems, was

quite possible in the special circumstances of the depression. If the growth of values fully equaled the monetary ination before the price ination could take hold, there would be no price ination. Inationary potential is thus not necessarily limited by the supply of values which the nation is actually buying at any moment, but by the possibly larger supply which it is potentially capable of producing and consuming. This is all that Keynes meant when he said that his monetary ination was justied whenever an economy was producing below its capacity, and in that case would have no corresponding inationary eect on prices. Before leaping to the conclusion that creating money would have created wealth and prosperity, notice that it was not the money that would do it but the improved utilization of people and plant. People and factories were being held back by unnatural psychological restraints, and money might free them. Money could create no real values, but it might free the people to create them. The theory was that in grossly depressed economic circumstances mone tary ination might have all of its usual good eects and none of its usual bad ones. The theory was not unsound, and the medicine might be right. In practice, the results were likely to be more mixed, but they might still be quite favorable. In any event, the Great Depression in which the pre scription might be correct was a special case and not the general case. The circumstances of that depression had never existed before in the industrial era and never again existed afterward. The attempt to prescribe the same medicine in another era such as the thirty-year American ination was quite another story.

134

26 Inationary Economics Keynes made a great point of the generality of his General Theory, from the very rst sentence ("placing the emphasis on the prex general") through out. His was to be a theory for all seasons, not just a depression, or so he thought. If his followers erred in applying the theory to dierent circum stances, Keynes was not without fault in pointing the way. But Keynes' sin was only the sin of overreaching, not of being wrong. He sought to make a universal out of a good thing when he could not. His general theory was only a special case, and Keynes himself would have discovered that much sooner than his followers did. Deep depression was peculiar to the

1930's,

but insucient prosperity

was not. One of Keynes' most vital departures from the classical economics was to state that a developed economy might very well settle to an equi librium level which represented less than full employment. In other words, unemployment might be chronic. According to Keynes, the classical eco nomics had said that production creates its own demand, and economic equilibrium has a natural tendency to provide as much work as people want. The probability of chronic underemployment in a developed economy can not be refuted. The evidence supports Keynes. This is the same point that was made earlier in noting that insucient prosperity, recession, and un employment resulted in postwar America whenever money was restrained enough to prevent ination. It is the same as saying that stabilized money policy alone would not solve the problem of prosperity. chronic underemployment are not dicult to nd.

The reasons for

The more technologi

cally developed an economy becomes, the fewer workers the economy will need to produce its output, but the more people will need work and the means to acquire the output.

At the extreme, an economy might be so

perfectly automated that it needed no workers whatever to produce all the needs of all the people, but for lack of work the people could not buy any of their needs. As far as America had yet progressed, the gap between need

135

26 Inationary Economics for workers and workers' needs was much less wide than this, but in mod ern industrial societies it could only become wider. Keynes himself alluded to this problem perceptively in an earlier (1930) article entitled

Possibilities for Our Grandchildren.

Economic

If underemployment and insucient prosperity were to be chronic, Key nesian economists proposed to deal with them by slavishly using the same prescription as Keynes proposed in the Depression.

In short, they pro

posed a continuous monetary ination. The same possibility of increasing the saleable supply of values by employing unused resources should im prove prosperity and avoid ination, or so the theory went.

The theory

was wrong. The premise might be sound, but the conclusion did not fol low. It is precisely by the application of this faulty syllogism that the entire line of descent of Keynesian economists went so far astray. The hope that the real growth in the saleable supply of values may be at least as much as the monetary ination, thereby avoiding price ination, is illusory. The amount of production that the people can be induced to consume is nite, more so than the number of people needing work. In the depression, a rate of production and consumption at least as good as in the

1920's

had already been proved possible, and therefore a growth back

to that level was a reasonably good possibility.

In a developed economy

operating at reasonably normal vigor, as the United States was doing at all times after World War II, the possibility of achieving that kind of real growth is slight.

This is true even though there may be unemployment.

More workers are not needed. Most people already have most of what they want, and if more is crammed down their throats it is through articially induced wants which are as wasteful and disturbing as unemployment is. The unemployed persons themselves often do not have qualications that the system can use; if the machine is driven ever harder the unemployed mostly remain unemployed while the machine threatens to burst. In the extreme situation in which an automated economy produces everything, monetary ination to stimulate employment could not correct the insu cient prosperity at all.

Stimulate as one might, this economy still could

not use any workers, and the totally unemployed workers still could not buy any production. As economic development advances, therefore, unem ployment may become increasingly chronic, but monetary ination does nothing to help. Monetary ination does not produce more growth than itself, nor even as much. Through the economic waste of fostering spurious

136

activity at the expense of useful activity, it may indeed produce a net loss. This is not to say that monetary ination does not work at all. It does. Monetary ination has just as marvelously stimulative short-term eects in relatively normal times as it does in depression. It is a potent medicine at any time, its ecacy is almost perfect, it always works in the beginning. It is in the longer term that its threat of harm lies. In a depression, monetary ination might do no harm even in the long term. At any other time, its long-term harm is greater than its short-term good. Keynes set the tone for his followers by his quip about all being dead in the long run. Monetary inationists love to make the short run their own and leave the long run to someone else, but those of us who may be condemned to live the longer run might well give heed to both. Since monetary ination does work, it is worth knowing why it works. If we know that, perhaps we can nd something else that might work just as well. Assume an economy which is in a state of insucient prosperity. It is not depressed, unemployment is not rampant, but still it is not suciently prosperous. Business is not booming, well-being is not rising fast, and peo ple have diculty getting jobs as good or pay as high as they would like. There is some involuntary unemployment. At this point the government indulges in a monetary ination.

This is done either by putting a dose

of cheapened money into circulation or by borrowing and spending more than its taxes, or both. At the opening instant, the ination only makes the original recipients of the money feel richer in the static sense of money in hand.

Almost immediately the money begins to ow and stimulates

business activity throughout the economy. Who the rst beneciaries are depends on how the government chooses to distribute the inated money, but is not of lasting importance. The stimulus reaches almost everyone. If the government buys space rockets or military goods, rst the contractors and workers in those industries will feel the prosperity, and later all the other industries that sell to them. If the government lifts social benets, rst the payees and then the consumer industries will benet. If the gov ernment makes general credit cheap, rst the bankers and then the capital goods industries will prosper, and then the other industries they buy from. Prots rise, wages rise, workers are in demand, a few unemployed will be employed, insucient prosperity is rectied, and there is a boom. Where did all that spending power come from? The initial ination was

137

26 Inationary Economics only a few billion dollars worth of new money or new debt, and anyway we know that money or paper debt creates no real value. The spending power was real value, however, and it must have come from somewhere. And so it did. At the opening instant, the equilibrium value of money decreased by exactly the amount of the monetary ination.

More than that, the

real value of all the money wealth in the nation decreased in the same proportion. These eects were still latent, actual prices had not changed, the apparent values of money and money wealth had not changed, and therefore the recipients of the inated money were richer by the amount of the ination while no one else was as yet apparently poorer by any amount. Nevertheless, the transfers of value had occurred at the opening instant when the equilibrium values of money and wealth were reset. Real value equal to the ination had moved from the holders of money to the government or the bankers and borrowers. Real value proportional to the ination had moved from the holders of money wealth to their debtors. The underlying ow of real values was exactly the same as if the government had taxed away the same amount of real value from its holders and spent it. Price ination is slow to follow, but it does follow. The price ination is the cost of the original prosperity. Price ination is the collection from the money wealth of the tax which had already been levied and spent on the prosperity at the opening moment. If no real gain in values was produced by the ination, as it seldom is, the cost is exactly equal to the value of the original prosperity. If we look through the layer of paper decits and paper wealth, which do not mean anything, to the ows of real values, which do, we see that none are created and none destroyed but only redistributed. The tax on money wealth is of course not necessarily collected from the original holder.

If he is clever enough to dispose of money property

before the price ination comes, he escapes the tax.

The tax is paid by

the incautious person who is caught holding the wealth when the price ination does come. Money ination thus works no magic but only a simple, massive, and surreptitious tax on money wealth, and the payers of the tax select themselves to be taxed by their own dullwittedness in holding the taxed property.

The inationary tax is the easiest of all taxes to levy,

indeed so easy that it is more dicult not to levy it, and in the beginning at least is also the richest of all possible taxes. Other than that, it holds no magic. No real wealth is created, only seized. The government's accounts

138

always balance, notwithstanding decits on paper. It is impossible for the government to run a decit in real terms, for whatever the government spends automatically pays for itself by exacting its cost from someone. To understand the magnitude of the inationary tax, consider the sit uation that existed when the great ination began in October of

1962.

Beginning then, the government inated the money supply in the next twelve months by about $6 billion, or

4

percent. That amount was about

the same size as the Federal budget decits of those years, but the budget decit was not important. Inating by a

3

4

percent, the government also laid

percent tax on the entire body of money wealth that existed in the

United States at that time. Money wealth is equivalent to total debt, and total debt was then about $1.8 trillion, so that a

3

percent tax on money

wealth would have yielded about $54 billion per year.

The nation could

obviously buy itself quite a prosperity with $54 billion of real values to distribute to various citizens, considering that the entire Federal budget at that time was only about $111 billion.

Notice the enormous leverage

that was obtained from a small money ination by the presence of a large money wealth.

Only $5 billion was taxed away from the holders of the

money supply proper, a comparatively small amount, but more than ten times that amount of real value was taxed away from the holders of the remainder of the money wealth. This was where the prosperity came from. Ination as a tax is not unknown to economics in spite of being obvious, although there is a tendency to think of the tax as falling only on the money supply proper and to overlook the much larger tax on the remainder of the money wealth. Once again, the outstanding exposition of the inationary tax was given by none other than John Maynard Keynes at a time (1922) when ination was the world's problem. His article, Ination as a Method of Taxation, expressed the following thoughts among others: A Government can pay its way . . . by printing paper money. That is to say, it can by this means secure the command of real resources  resources just as real as those obtained by taxation. The method is reprobated, but its eciency cannot be disputed.

A Government can live by this means when it

can live by no other.

This is the form of taxing the people

which it is most dicult to evade and which even the weakest Government can enforce when it can enforce nothing else. On whom has the tax fallen? Clearly on the holders of the

139

26 Inationary Economics original notes . . . The burden of the tax is well spread, cannot be evaded, costs nothing to collect, and falls, in a rough sort of way, in proportion to the wealth of the victim. No wonder its supercial advantages have attracted Ministers of Finance. Experience shows that the public generally is very slow to grasp the situation and embrace the remedy. . . . But sooner or later the second phase sets in. The public discover, in eect, that it is the holders of notes who suer taxation and defray the expenses of government, and they begin to change their habits and economise in the holding of notes. . . .

The public try to

protect themselves in this way when they have convinced by experience that their money is always falling in value and that every holder of it loses. It is common to speak as though, when a Government pays its way by ination, the people of the country avoid taxation. That is not so. . . . The same arguments which I have here applied to the note issue can be extended, with a few modications, to all the forms of internal Government debt. . . . What a Govern ment spends, the public pay for. There is no such thing as an uncovered decit,

(Italics added)

These words echo strangely from the man who was later claimed as men tor by the champions of the government decit.

Keynes' article was re

vised somewhat and reprinted as part of a remarkable book called A Tract on Monetary Reform in

1924,

a book which every putative Keynesian

economist might well be required to recite by heart and to harmonize with Keynes' other work before being allowed to practice Keynesian economics. What was extremely true of the extreme inations of that day is propor tionately true of the less extreme inations of a later day. We come now to the single most important law of ination.

It is so

tremendously important that we must at least capitalize its name, thus: The Law of the Exponential Ination; or perhaps italicize it, thus: The Law of the Exponential Ination. We may also think of it as a law of geometric progression, and it is simply this:

every ination must compound itself

at a geometrically increasing rate in order to continue to have the same benecial eects as in the beginning.

It means, in practical eect, that

every ination, once begun, must become continuously worse.

140

As little as a

4

percent rate of monetary ination, starting from stabil

ity, produces a thoroughly marvelous prosperity. We know that from the American experience.

The billions upon billions of dollars of real value

which a tax of this small size slyly collects from the money wealth provide unexampled well-being for everyone standing in the way of receiving some. But this is only true until price ination presents the bill.

Once prices

too have settled down to a steady rate of increase of perhaps a continuing

4

3

percent,

percent monetary ination has no benecial eects at all.

The tax no longer collects any yield. The state of prosperity, sucient or insucient, will be exactly the same as before the ination started, but now with steadily rising prices instead of steadily stable prices. To make everyone as well o as the

4

percent money ination originally did, the

government must now inate every year to a compound annual increase of

8.2

104

percent of

104

percent, or

percent. And so on. That is the Law

of the Exponential Ination. The proof of this likewise is readily found in the American experience.

4 percent per year produced an 1955, and the same rate another excellent boom in 1963, in both cases starting from stability, but by 1970 the very same rate of money ination was good only for a recession and a nancial crisis. A 6.5

A rate of money ination of less than excellent boom in

percent annual rate of monetary ination could fuel the most fantastic of all booms in

1967

and

1968,

but by

1973 it too was beginning 1973 was well trapped

a recessionary rate. The government in

to look like by the Law

of the Exponential Ination. If it be asked how a few percentage points per year of increased money supply can make so much dierence, consider this: every one percentage point of increase may amount to only $2.6 billion more of money quantity in, say,

1973

(when the money supply was $260 billion), but if every dollar

is used fty times a year that comes to more than $130 billion of new purchasing power poured into the system for each percentage point. At the

6.5 percent annual rate of money expansion which was actually prevailing in 1973, purchasing power was being increased each year by no less than $845 billion, which was two-thirds of the entire gross national product. Let no one seriously question the tremendous leverage exerted by mere percentage points of money ination. The Law of the Exponential Ination refutes the Keynesian economists' comfortable proposition that a modern economy must and can have a little

141

26 Inationary Economics steady ination in order to have a sucient prosperity. It was true enough that the United States could not seem to obtain sucient prosperity with out at least a little inationary money expansion. But if the nation could not do without a little ination, it certainly could not stop with only a little ination. Once any rate of ination had been stabilized, it would no longer do any good and more would be required. The only dierence between a little ination and a lot of ination is time. Low rates do not compound themselves as rapidly as high rates, but by the Law of the Exponential Ination they still do compound themselves to equally high ultimate rates in a somewhat longer time. Whenever a government remedies insucient prosperity with monetary ination, the price falls due and payable later in price ination. Rather than pay the price, the government normally will indulge in additional monetary ination.

The ill eects otherwise would be so ill, the prosperity again

so insucient, that the government will inate more rapidly as necessary rather than suer them.

This can go on as long as the government has

the courage or lack of courage to keep increasing the ination, and the public the obtuseness to tolerate it. If the ination stops increasing, the government will have the same insucient prosperity as in the beginning but with steadily rising prices. A return to stable prices is practically out of the question, because a return from steady ination to stability would cause the same deep depression in prosperity as an outright deation would have had in the beginning. Since we are all Keynesians today, we are all monetary inationists today. Admittedly or not, all Keynesian economists are monetarists. There were no other kinds of economists extant in the American ination. Monetary ination progressed from a radical economic tool for the Great Depression to literally the only management tool in the economic tool chest. Conserva tives and liberals alike, Republicans and Democrats, oered nothing else. A conservative was one who advocated a more sparing use of ination, and he showed frequent stagnation and creeping ination for his caution.

A

liberal was one who advocated a more exuberant use, and he showed more truly magnicent binges and stemwinding hangovers for his enthusiasm. Neither of them had one single alternative to oer, and both left us all equally well checkmated by the universal Law of the Exponential Ination.

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27 The Economics of Disaster The economics of inationary disaster are a simple process which need not detain us long. The economics of disaster are as simple as the inationary economics were complex. The government was the managing proprietor of the inationary economics, but the economics of disaster are conducted by persons other than the government and are largely beyond the government's control.

Inationary economics required motive power supplied by the

government, but the economics of disaster are self-propelled.

It is the

government that decides when and how fast the inationary reservoirs shall be lled, but it is something else that decides when the dam shall burst. The economics of disaster commence when the holders of money wealth revolt. It is as simple as that. The government has little or nothing to say or do about it. Its policies are scarcely worse or dierent than they have been all along. They may even be better, as they were in Germany in

1922.

Holders of money wealth express their revolt by the simple act of get ting rid of their money and money wealth and declining to hold it in the future any longer than necessary to get rid of it. They do not y ags or demonstrate in the streets to express their revolt; they simply get rid of their money. When a sucient inationary potential has been laid up by the government in all the available reservoirs, that is all that is necessary. If the simple desertion of the money becomes widespread or universal, the latent ination surfaces in the form of disaster. The duller the holders of money wealth are, the longer the government can go on storing up ina tion but, by the same token, the more cataclysmic must the eventual dam burst be. The Germans were among the dullest and most disciplined of all holders of money wealth, and this alone permitted the government to build up so huge a pool of unrealized ination before the burst. The desertion of the money holders has many of the aspects of a panic, like any desertion in the thick of a struggle.

All may be orderly in one

moment and in full ight in the next. As slow and imperceptible as the inationary economics were, the economics of disaster are sudden and unex

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27 The Economics of Disaster pected. A lling of reservoirs which may have taken years may be emptied in a day. The reservoirs where the inationary potential has been stored are those we have already described. Money velocity which has lagged behind its nat ural level throughout the incipient ination may suddenly multiply itself many times over as holders dump their money. Prices of desirable things rise accordingly.

Government debt which for long has immobilized some

of the inated money now is deserted by existing money and turns into money itself. Fractional-reserve banking turns the new money into multi ples of additional money. Money which has been engaged in servicing the enormous money wealth now deserts the money wealth and seeks real as sets instead. Even the money which has been occupied in markets for real investments such as industrial stocks may lose heart in the face of falling prots and hard times, and come forth in search of surer value. Even the money which has been occupied in buying and selling goods and services, many of them useless, deserts them in favor of essentials like food and land. In a collapsing ination, people's powers of discrimination between real val ues and spurious values become suddenly acute, and the apparent supply of saleable real values falls. Foreign holders of the money take fright too, and their money elbows its way into the markets and reverses any balance of payments decit. Finally, the government nds itself deprived of its in ationary tax while its regular taxes yield little, and it resorts to still more money ination as a means of nance. In so doing, the pathetic government trails far in the dust of the eeing citizenry. Like any panic, the economics of disaster tend to overshoot the ination ary potential. If the government did nothing to add any more money to the ood, some but not all of the ination resulting from the bursting of the dam would subside. Money velocity is a good example. We saw earlier that velocity can easily increase tenfold in a bad ination, and if it does prices must also increase tenfold based on velocity alone. But velocity is transitory, and if the ination stops, velocity will subside and prices must fall again by nine-tenths. The same is true of investment in real values like industrial stocks. If ination stops and normality is recovered, money will return to sound investment and the prices of other kinds of values must decline accordingly.

But the ination based on the abandonment of the

former money wealth and spurious values tends to be permanent, and this amount of ination is more than enough to leave a tremendous destruction

144

in its wake.

Moreover, the government seldom stops inating cleanly or

soon. The bursting of the dam is hot to be minimized. There is no good way of estimating what point is the breaking point for the economics of disaster. There is also no use in planning for what to do in the event of disaster, since nothing much can be done about it. The United States even in

1973

was still far short of the revolt of its money holders,

even after a decade of continuous theft from them. There was not the least sign of any dumping of dollar property by either citizens or foreigners. The unrealized depreciation of the dollar was probably no more than a fth as great as that of the Reichsmark when the ight from the mark began. In the turmoil of the time, the Germans had much more psychological cause to take fright than Americans did in

1973.

This book does not proclaim

that the bursting of the dam was at hand. It does say that the reservoirs were already partly full and lling. Americans must learn to live with this fact like the people who live out their lives in a valley below a great dam, but when a freshening stream of ination was found issuing from a crack in the dam it could not be treated like an innocent brooklet rising from a pure little spring in the hills. The point to be taken to heart by any American government is that the degeneration of an ination into a catastrophe is not the willful act of the government. A government does not remain safe from disaster simply by abstaining from extreme misdeed.

No government collapses its currency

because it wishes to or because it agrantly does not care. When at last it sees the choice, it has no choice. People take over, and the government is relieved of its command. Neither is a government safe because the point of mutiny is still far o. When once a government embarks on the course of monetary ination, it is forced ever forward by the iron Law of the Exponential Ination.

The government is trapped between, at its back,

the money wealth and the necessity to mine from it at an increasing rate, and, before it, the necessity that the holders of money wealth voluntarily permit the mining.

No matter how distant they may be, revolt of the

creditors and inationary collapse are ultimately certain unless at some timely moment the government and the people elect the supreme act of self-denial by stopping the ination and swallowing the accumulated stores of hardship and injury. O how we earn an awful fate, when rst we practice to inate.

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27 The Economics of Disaster

146

28 The Crux Here we come to the crossing of the ways, or the crux of the matter as the Latin usage would have it, and it will pay us to pause and look at the road signs at this crossing of the ways before we leave it.

Here the two

divergent paths of thought in American economics converged. Here there was a conuence of dissimilar streams of thought that sprang from remote and uncongenial sources. Here the issue was joined, the battle lines were drawn, and to our surprise we nd that the battle was a draw. The travelers down one of the two paths  adherents of what is com monly thought of as the main force of Keynesian economics  declared that they can purchase prosperity with a policy of continuous government decits and easy money, that if this caused a little ination it was not pos sible to have sucient prosperity without a little ination. Experience in the United States proved them correct. The travelers down the other path  monetarists who are loosely allied around the banner of Milton Friedman  declared that the policies of the rst group amounted to nothing but monetary ination, that their eco nomic stimulation resulted from the government's tampering with money, that ination also resulted from the government's tampering with money, and that if a little ination was tolerated it must constantly increase to more and more ination. Experience also proved them correct. Both were correct. Neither was wrong. Each of the two kinds of economist held the truth of half a theory, and ne'er the twain had met as yet. In the existing economic organization of the United States, sucient prosperity could not be obtained without monetary ination, but to obtain sucient prosperity continuously monetary ination must compound itself exponen tially to the point of ultimate collapse. Which way then to economic health? The answers that economics gave suggested that there was no way. They remind us of the Maine Yankee who, when asked directions to a nearby place in Maine, replied sadly, "You can't get there from here." On its face, this is absurd. On their face, the answers of economics were

147

28 The Crux absurd. You can get to anywhere from anywhere else, if you are willing to blaze your own routes. To say this is no mere uninformed bravado. In the nature of things, it is true. We need no evidence to prove it. In the nature of things, a nation which is as economically strong and as untroubled by real handicaps as the United States was must be, if not healthy, at least capable of being healthy. It could do better than economics had done so far. But not by traveling the established roads. From this crossing, the road signs do us no good.

One road leads only to accelerating ination, and

the other road leads only to worsening stagnation. The traveled ways do not go where we want to go. To get there, we have no choice but to take leave of the traveled ways and strike out across country. Bring your hiking boots.

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29 Taxes The idea of taxes is a strangely neglected idea. There is no lack of taxes in the modern world, to be sure, but the conception of what the taxes are doing economically is sorely neglected. Taxes are the great engine and the sole motive power of the government's economic management, but the government fails to understand its engine. If there was one single cause of the inationary failure of economic management by the government, it was the failure of the management to understand taxes. Ination, we have seen, was the one kind of tax that enabled the gov ernment's economic management to succeed even temporarily. Mysterious and surreptitious as it is, ination is still a tax. It works because it is a tax, and more especially because it is a certain kind of tax, a capital tax. It must follow that any other tax of equal amount and comparable incidence would work just as well.

And if ination, although it works, has other

serious drawbacks, it follows too that the remedy for ination's evils is to nd other equivalent taxes that do not have such drawbacks. All government nance consists of branches of tax policy. Even monetary policy is a branch of tax policy. An inationary policy represents a decision to include the ination tax on capital in the tax structure. A deationary monetary policy would represent the decision to include the deation tax on debtors in the tax structure. Fiscal policy too, meaning decit or surplus in the government's budget, is a part of the monetary branch of tax policy. Since it is not possible for the government to run either a decit or a surplus in real terms, but only to secrete the monetary ination or deation tax in their guise, scal policy represents merely an indirect choice to include either the ination tax or the deation tax in the tax structure. A monetary and scal policy which was perfectly non-inationary and non-deationary would represent a decision not to use monetary manipulation as part of the tax structure at all, but to rely instead on overt rather than covert taxes to accomplish the purposes of economic management. The government has no power not to tax to the full extent of its expenditure, but only the power

149

29 Taxes to select one kind of tax rather than another. The most complex questions of government economic management thus mostly boil down to matters of the design and selection of taxes. In view of the vastness of all taxes, including ination, in the economic system, the complete failure of the economic management and the economic profession to grasp the fundamental importance of tax design during the American ination was astounding. Keynes' General Theory, their theoret ical foundation, contained not a single word of discussion of tax structure, which is astonishing for a work that claimed to be a general theory of the economic problem. Sophisticated economics, searching about for the magic talisman to economic health, devoted itself to every other kind of gimmick such as low interest rates, cheap money, budget decits, and investment incentives, but all of these amounted to no more than an uncomprehending use of the ination tax.

The cleverest use of true taxes that economics

could devise was to raise taxes as a whole for a budget surplus, or more often to lower them as a whole for a budget decit. Either way, this un-d ierentiated manipulation of taxes as a whole was the crudest imaginable sort of tax policy. Taxes are not a monolithic mass. Taxes are of many kinds. There are income taxes, sales and excise taxes, property taxes, and inheritance taxes, and then there is the ination tax. The variety of dierent kinds of possible taxes is virtually innite.

Everyone knows this, and there was even a

certain amount of study by tax economists of the dierences in incidence of dierent kinds of taxes, which means which kinds of people bear the burden of particular kinds of tax.

But this study was rudimentary at

best, and understanding of the dierent eects of dierent kinds of taxes, including the ination tax, was inadequate. Economic life runs in two parallel channels, and the important dierence between taxes is their relative drain from these two parallel channels. The two channels may be called saving and consumption, or they may be called capital and labor for the classes of people who are most closely identied with saving and consumption, respectively. Most people's lives participate at least a little in both channels. Most people work and all people consume, and therefore they are a part of the labor and consumption channel. On the other hand, most people also save something and hold some sort of capital, even if only by participating in some employer's pension plan, and therefore they are also a part of the capital and saving channel. The

150

opposition between the two channels is therefore not a class conict of one group of people against a separate group of people, but a counterpoise of two separate streams in all people's lives. The government's duty of economic management consists of nothing more nor less than regulating the relative ows in these two separate chan nels  saving or consumption, capital or labor  so that they are in balance, not necessarily equal but in balance.

The proper object of this

economic management is not to benet disproportionately one group of people which they or someone else decide is disfavored, nor is it to de prive some other group which someone decides is too well favored. Since both channels are of equal merit and both contribute equally to economic well-being, the proper object of economic management is to balance their ows in such a way that both channels ow most copiously for the benet of everyone. The way economic management balances the ows in the two channels is to draw ow from one channel  taxation  and divert it to the other  expenditure. In an early stage of economic development, the necessity of sound economic management is to draw ow from the channel of labor and consumption and to divert it into saving and the formation of capital. In a mature stage of economic development such as the United States had gained at the time of its ination, the necessity is exactly the opposite, namely to draw ow from oversaving and the abundant fruits of capital and pour it back into consumption. The early stage of development is well illustrated by the industrial growth of the United States in the nineteenth and early twentieth centuries. At that time, as in any economically undeveloped nation, the total ow in both of the two channels combined was meager, because the aggregate product of the nation was low.

There might have seemed to be great

hardship involved in diverting a substantial part of that meager product away from consumption by the workers who produced it and channeling it into the formation of capital, which meant building factories and railroads and capital equipment for the capitalist barons who would own it. Yet that was what was required, and it made no dierence whether capitalist barons or the government owned it, except that it would happen more quickly if capitalist barons had the lure of private ownership. Without that kind of injustice and hardship, no nation would ever develop.

Without taking a

painfully large part of a painfully small product away from consumption

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29 Taxes and investing it in capital, that small product could never be made larger. That was the requirement of economic management in the earlier days of the United States, and by the purest historical accident it was met perfectly by the laissez fairs inaction of a government that was quite unaware of what it was doing. The super-full employment of that time, the low exploitation wages of the workers, the low consumption because of low wages, and the absence of taxes and other regulatory burdens to impede the burgeoning capital empires all contributed mightily and well to the explosive industrial growth of the United States. That growth could not have been achieved without any of those factors, and no similar growth will ever be achieved again, anywhere, without a similar balance of factors. The mature stage of economic development which the United States later reached was exactly the opposite in almost every respect. The task of eco nomic management was theoretically much easier, because the total ows in the two channels had become abundant, but paradoxically the govern ment experienced much greater diculty attempting to master this much easier task.

In the mature stage, the capital installation is largely com

pleted, total output is large, and workers are much less needed either for current output or for the formation of new capital.

As Keynes correctly

pointed out, there is a chronic tendency in an advanced economy to ex cessive saving and insucient consuming.

The larger total incomes are,

the more inclined people are to save larger parts of those incomes, but the less need there is for the formation of still more capital that could absorb these large new savings. The Keynesian solution to this was to stimulate new investment articially, but there is a clear practical limit to how much articial new investment can be stimulated, and the problem soon outruns the solution. What is needed most is that the abundant production of the existing capital system be consumed, and that the people through labor or other-wise be able to obtain the means of consuming it. What is needed is that the ows in the two channels be balanced by constantly drawing some of the ow from oversaving and diverting it back into consumption. In the extreme case of maturity where all possible needs of all people were supplied by capital, no workers were needed, no further capital investment was possible, and all saving was excessive, the holders of capital would hold all the means of producing but the rest of the people would have no means of buying, and capitalists and other people alike would be destitute unless enough of the fruits of capital were diverted to consumption to allow people

152

other than capitalists to buy the product of capital. It is not a matter of moral rectitude that capital should partly support consumption in this way, any more than it was morally right that exploited workers should support the formation of capital in an earlier century. It is not a matter of justice, but merely of necessity. The government's duty of balancing the ows is performed in two ba sic steps.

The rst is to draw values from its citizens, and this step is

taxation.

The second step is to redistribute the same values to its citi

zens, and this step is government expenditure.

The economic balancing

aspect of this two-step operation lies in the relative dierence between the groups of citizens from whom values are drawn and those to whom they are distributed. Redistribution of values among citizens is thus the essence of the government's economic management. Where the imperative of eco nomic management is to draw from capital and distribute to consumption, the government's mandate is to tax more heavily those who save or hold capital and distribute more liberally to those who consume. Of distribution through government expenditure, more will be said in a later chapter. Taxation is the intake side of the two-step process. Tax design is much the more important and dicult of the two sides, the other being expendi ture policy. In an ideal tax system, the government would have an array of dierent kinds of taxes, each bearing more heavily on one economic sector like capital or consumption than on the other. Sales taxes, for example, are a direct restraint of consumption. Property taxes, inheritance taxes, and corporate income taxes are taxes on capital. Income taxes are mixed taxes but weigh somewhat more heavily on consumption power than on capital. Judiciously using the complete array of these taxes, the government could raise the capital taxes relatively when saving was too high and consumption too low, and raise the sales and income taxes relatively when consumption was too high and the formation of capital too low. Broad enough taxes like these would act as sluice gates in the two conduits and, shrewdly enough used, would give positive regulation of the ows in all conceivable economic circumstances. The need in various times might be for exible taxes, but the need in the United States at the peak of its ination was for capital taxes. Since the necessity in a mature economy was to draw continuously from capital and distribute continuously to consumption, taxes on capital must be heavier

153

29 Taxes than on income or consumption, and over the course of time they proba bly must grow still more disproportionately heavy. In the past, the need for a large and heavy capital tax had been met successfully, but only by the government's reliance almost exclusively on the ination tax. Money ination operated on both the tax side and the distribution side, because much of the value levied by ination moved directly from creditors, who saved and held capital, to debtors, who spent and consumed. The tens of billions of dollars of value each year which the government levied from capi tal and distributed to consumption by ination represented the only source the government had found rich enough to do the job. Talk of stimulative decits and low interest rates and investment incentives was nonsense. The policies underlying the talk did accomplish the purpose, but the way they accomplished it was by redistribution from capital to consumption through the ination tax. If monetary ination worked because it was a simple tax on part of capital, but ination was bad, then of course some other comparable tax on capital could work just as well and might not be so bad.

Counting

ination, the United States already had all the heavy taxes on capital it needed. Something like a moderate net-worth tax on all of capital, which was unknown in the United States but eectively used in many European countries, could easily have substituted for the ination component in the capital tax structure. More about particular taxes will be said in the next chapter. The point here is that if deliverance from ination were ever to be achieved, new capital taxes of comparable magnitude must be instituted. It was not so important exactly what the capital taxes were as that they be large. Taxes are never fun. No one would rather be taxed than not be taxed. The idea of capital taxes strikes fear and rage into the heart of capitalist America, although in fact capitalist America throve quite nicely under an existing load of capital taxes which were adequately heavy when the ina tion tax was gured into account. Disproportionately heavy capital taxes are not anti-capitalist, but the reverse.

Only by means of capital taxes

can a capitalist economy be made to work at all in an advanced state of development. A well-balanced economic management is as much better for capitalists as it is for workers and consumers.

If capitalists who increas

ingly monopolize productive power do not allow enough buying power to be diverted from themselves to their consumers, there will be no prots

154

for capitalists either. The correct level of capital taxes is high and grow ing higher, but not consca-tory. The correct level of capital taxes is that which achieves the maximum ow in the channels of both capital and con sumption. Higher capital taxes than that are bad, and everyone, capitalists and workers and consumers alike, will be worse o.

Lower capital taxes

than that are also bad, with the same result. Capital taxes of the proper high level are as benecial to capitalists as to any other member of society. High taxes on capital do not destroy capital, as is sometimes charged, nor do they inhibit the formation of new capital, either of which eects would be bad. When a man pays a property tax on his house (a capital tax), he does not saw o a piece of his house and give it to the tax collector, thereby destroying that much of his capital. Not at all. He takes some of his income from some other source, measured not by the income but by the value of the house, and pays that to the tax collector. The house is intact. All taxes, including capital taxes, are income taxes in the sense that the means of paying them must come from income. A capital tax is a tax paid out of income but measured by the voluntary exercise of the privilege of holding property.

Until the tax becomes so high that the privilege is

no longer attractive, capital taxes neither destroy capital nor dampen the formation and acquisition of new capital. The privilege of holding property is a deep and powerful motivating force.

It is this unique privilege that

caused capitalistic systems to succeed, and capitalistic systems can continue to reap ample harvests from this fertile source.

People do not cease to

own houses because the property taxes on them are high, nor to hold investments because they are taxed heavily.

No one should fear to tax

the privilege lest people might be driven to foresake it, and on the other hand if the privilege is not taxed it will wither. If there is one precept which even the archest conservative must receive from Lord Keynes, it is that an economy as complex and interdependent and as completed as mature America must be managed by the government. Laissez faire in the strictest sense no longer would do. Conservatives who did not accept this would nd they were conserving a desert.

Not only

must the economy be managed, which is a declaration tinged with desper ation, but it can be managed, which is a declaration steeped in hope. Past failures by the kinds of economists who most strongly advocated govern ment intervention were no evidence that management could not succeed. Government management could continuously redress chronic economic im

155

29 Taxes balances, like that between capital and consumption, to the end that the economy produce the most for everyone. Government management cannot create wealth, but it can set free the eorts of willing people to create wealth. In all of this, the rst and strongest set of tools the government can have is a comprehending use of its taxes.

156

30 American Taxes If tax structure is at the heart of the modern economic problem, the Amer ican tax structure in the ination was from every relevant viewpoint a monstrosity. It was scarcely less absurd than the tax structure that forced Germany into the World War I ination, lacking even so much as a sin gle broad-based tax available to the central government rather than the component states.

American taxes began with a

1913

framework that

was poorly conceived at its building and was never fundamentally remod elled.

They progressed through myriad clumsy modications until the

labyrinthine handiwork that remained resembled what the Capitol build ing might have looked like if the elected legislators had been allowed, in committee, to draw the plans and erect the stonework. The principal absurdities of the American tax structure fell into two main categories. The rst was a complete inability to mount capital taxes su ciently broad and massive to relieve the need for ination. The second was an extreme proclivity for needless complexities and articial distinctions which stimulated the useless, hindered the useful, and bewildered every one. Many of the principal absurdities had a foot in each category. The principal absurdities that bear mention were in the areas of net worth taxes, inheritance taxes, capital gains taxes, corporation taxes, and progressive income taxes. Net worth taxes in the American tax structure were absurd by their ab sence. Comprehensive net worth taxes were unknown to the United States, although many of the Continental European nations including Germany, the Netherlands, Luxembourg, Switzerland, and all the Scandinavian coun tries had smoothly functioning net worth taxes as important parts of their tax structures. A net worth tax is the broadest and most direct imaginable tax on all of capital and only capital. If ever any tax promised to be broad enough and massive enough to take the place of the ination tax on money wealth, it would be a net worth tax on all of wealth.

A net worth tax

sucient to do the job in the American structure would not have to be a

157

30 American Taxes heavy tax. A tax in the range of

2

percent of value in normal times, per

haps less, and higher only in times of emergency such as wartimes, would be enough.

A net yield of perhaps $30 billion of new revenue would be

about right. This net worth tax on the value of capital, in addition to a regular income tax on the balance of income from capital, would be what imposed on capital a total tax burden heavier to the correct degree than on personal income. Even so, most kinds of capital would bear a lighter total tax burden than they did under the existing American hodgepodge of cap ital taxes including corporate taxes, double dividend taxes, and ination taxes. A net worth tax could incorporate into a uniform structure the welter of local real estate taxes that threatened to crush many localities of the United States. Real estate taxes were peculiar to the English-speaking countries. Those countries of Continental Europe that used the greatly superior net worth tax generally did not have appreciable real estate taxes in addition. In the United States, cities and suburbs especially groaned under real estate tax loads running often to

3 percent of market value per year or more, while

it was estimated that the nationwide average of real estate taxes was only about

1.4 percent of value.

Large amounts of property therefore were being

inadequately taxed solely because of the localization of the taxes. It seems obvious that incorporating a uniform tax of no more than

2

percent on

real estate into a net worth tax on all property could provide the same amount of revenue for all the same purposes without crushing anyone. A net worth tax does present one technical problem in the accurate valuation of property. Sales taxes and income taxes do not have this problem, and the problem is not negligible. The problem is not insurmountable, however. Valuation is successfully accomplished every day in the administration of estate taxes, local real estate taxes, and the European taxes on net worth. The great advantages of the tax command that the problem simply be surmounted. The need for a comprehensive capital tax is so insistent that the goals of phasing out ination and phasing back in prosperity may well not be attainable without general net worth taxes. The inexplicable absence of signicant inheritance taxes was another strange mystery of the American tax law. There were Federal estate and gift taxes and state inheritance taxes, of course, and the inheritors who bore them thought they were unconscionably heavy, but the fact was that they were ludicrously light. The annual Federal revenue from estate and

158

gift taxes was only about $3.6 billion, which was less than the annual revenue from excise taxes on alcohol and scarcely more than one-tenth of one percent of the value of all private property in the United States. Estate tax rates were so low that an estate's value must be larger than $1.5 million

($35 million if there was a marital deduction for a surviving spouse) before it paid even as high a percentage of tax (34 percent) as a single man earning a mere $25,000 paid every year on his income.

The absence of adequate inheritance taxes was doubly strange because an unbroken line of distinguished authorities observed that an inheritance tax is among the wisest and justest of all taxes. Philosophers and economists like Adam Smith, John Stuart Mill, Bentham, Marshall, and Keynes, and statesmen and wealth holders as diverse as Jeerson, Lincoln, Theodore Roosevelt, Franklin Roosevelt, Hoover, and Carnegie expressed views sim ilar to this of Hoover: The estate tax, in moderation, is one of the most economi cally and socially desirable, or even necessary, of all taxes. If ever there was a painless time for society to tax heavily the wealth a man has accumulated, it is when he has died and nished with it. The tax is a pure tax on capital which the nation needs badly. Apart from the revenue, society might, by diminishing the ow of wealth downward from creator to descendant, diminish also the drearily familiar American institution of the useless or underproductive rich heir. By the same means society might stop depriving itself, through the immobilizing eects of excessive inherited wealth, of the best eorts of those who genetically ought to be among its most capable potential contributors. These social reasons are among the reasons why the nation's greatest men, including rich men, unanimously endorsed inheritance taxes. Despite the critical acclaim, inheritance taxes languished. A perceptive observer said, Its inadequacies methodically increase from one act to an other.

An excessive exemption is combined with inadequate

rates, and these are joined by signicant loopholes. This is perplexing because inheritance taxes do not face the rebellious re sistance of millions of voters which almost any other sound tax does. Sage thinkers like Mill and Keynes pointed out that there was better reason

159

30 American Taxes for heavy taxes on inheritance than on high incomes, but American taxes turned this comparison upside down to tax incomes heavily and inheri tances lightly. One can only surmise that the inherited rich had more time and money than the working rich to inuence tax-making Congresses. The remedy for inadequate inheritance taxes is to treat inheritances as income and tax them at the same rate as any other income. The economist

1938 book, and before that the very 1898 had treated inheritances as income. To a recip

Henry Simons endorsed this idea in a rst income tax act in

ient, inheritance is a simple addition to his means like any other income. If existing progressive rates of tax on income were too heavy as applied to inheritances, that was the fault of the progressive income tax and not the principle that inheritance is income. Besides treating inheritance as income, revision of the inheritance taxes would have to eliminate major channels of avoidance such as the huge $60,000 exemption, to some extent the marital deduction, and the ability to skip whole generations of tax by the clever use of trusts. If the basic exemption were eliminated, millions of smaller estates would become taxed substantially where they were previously not taxed at all. This is proper. A small legacy from a small estate is just as much windfall income to its recipient as a huge legacy from a huge estate. The millions of smaller estates are where the bulk of the capital and the revenue are, not in the few large estates. The great weakness of inheritance taxation always was that it was enviously concerned too much with breaking down great fortunes and not enough with drawing adequate revenue fairly from the capital of everyone.

35 percent and it applied to inheritances, something like $35 billion per year to assist net ination. A 35 percent tax rate would still leave

If the income tax rate were a at inheritances might yield worth taxes in replacing

65 percent of every estate to satisfy a decedent's wish to be generous to his heirs, and on the other hand would be heavy enough to break down a great fortune to a mere

27 percent of its original self within two generations after

the death of its creator. Massively increased inheritance taxes would have an inevitable tendency to lower the market prices of property of all kinds. The taxes could not be paid out of current income, and portions of more estates would have to be sold to pay the taxes.

Market supplies of property for sale would be

increased, and prices would be lower as a result. This is at least as good as it is bad. Tax revenues based on value would be lower than otherwise,

160

but that is not fatal. For every owner or seller that saw the value of his property decline, there would be a buyer who was enabled to buy it more cheaply than he formerly could. Even the seller or owner is not damaged because the earning power or other usefulness of the property is the same as ever, and he pays lower taxes on value. The eect of all these complex results is simply to lower the cost of property relative to personal income, and this is desirable. A mature society in which the stock of capital and other property is largely complete must nd a way of constantly recycling this limited supply of capital away from existing holders at their deaths and into the hands of the society's new contributors.

The opportunity

to acquire property is the capitalist system's most attractive prize, and the system is only as vigorous as it is capable of redistributing its prizes continuously to its new live contributors rather than to the heirs of its old dead ones.

Moderately high inheritance taxes, forcing liberal supplies of

property constantly on the market at lowered prices, do this. The capital gains tax at least was not an absentee, but was only half present in the American tax structure. Since

1921

there had been special

favors in the tax law for capital gains, most recently a tax at just half the rate that applied to other income.

No arbitrary distinction in the

American tax law contributed more mischief to American life than the distinction between capital gain and ordinary income. Whole subchapters and hundreds of pages of the tax code were devoted to complex provisions whose sole reason for existing was the articial favoring of capital gain over ordinary income. Every new tax act compounded these complexities further.

The alluring tax advantages of capital gains sucked money into

the most speculative and insubstantial kinds of investment, seeking capital gains in preference to old-fashioned income like dividends and interest. The capital gains tax was at the bottom of many an unhealthy American stock market boom.

Lord Keynes advocated extra-heavy transfer taxes

as a deterrent, certainly not extra-light taxes as an inducement, to the American love of speculation. If a capital gain is a real gain and not an inationary paper prot, there is no possible justication for taxing it in any way except like all other income. If the progressive ordinary tax was too heavy for large one-time capital gains, that again was the fault of the progressive income tax and not of the principle that capital gain is income. Capital gains taxes actually work in powerfully conicting ways at dier ent points in an ination. In the early ination boom like the

1960's, when

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30 American Taxes huge capital gains were found under every stone and they were real gains because there was no price ination, taxes at only half ordinary rates were far too low and were unjustiable. But in a later ination like the

1970's,

when capital gains were still everywhere because of the price ination but they were mostly paper gains and not real gains, taxes even at only half the ordinary rate were taxes on capital and not on gain and were far too high. The solution to this problem was not too dicult: the cost or "tax basis" of each investment might be adjusted by the factor of ination since its purchase, and the balance of gain, being real gain, might then justly be taxed as ordinary income. In the circumstances of

1973,

this might actu

ally amount to a substantial reduction of taxes on capital gains, which is unfortunate but proper. A properly designed capital gains tax would never be a large revenue producer at any time except an early inationary boom, because in real terms and conditions of stability there would be compara tively little capital gain in excess of capital losses. Other kinds of capital taxes must take up the slack. Corporation taxes were another set of arbitrary distinctions in the Amer ican tax law. These distinctions were pure at heart, but their reason was weak. First, the income tax rate of corporations was higher than that of most individuals, although lower than that of some individuals. There was no good reason for any dierence.

Second, after a corporation's income

was taxed once at the corporate rate, it was taxed again if it was paid out to stockholders as dividends. It was not taxed twice this way if it was paid out to a creditor as interest, nor was it taxed twice if the business organization was a partnership or something other than an ordinary corpo ration. A more irrational arrangement for taxes on business could scarcely be conceived. These irrationalities were pure at heart because they did manage in a bungling sort of way to raise the taxes on capital to a passable level. Most capital was still held in corporations, and the largest of them still did pay dividends. The higher corporate taxes and the double taxes on dividends therefore did raise the overall tax burden on capital in comparison with the tax burden on personal income and consumption.

In so doing, they

created more hundreds of pages of tax code complexities founded solely on the articial dierences between corporations and other taxpayers or between dividends and other income. What is worse, these dierences let far too much capital (paying no dividends or earning no income) go scot

162

free of its share of taxes, and they created too strong an inducement to corporations to accumulate income when the most economically ecient use might be to distribute the income to stockholders as dividends and let them re-employ it elsewhere. Correct reform of corporate taxes would make the income tax rate ap plicable to corporations the same as applicable to all other taxpayers, and furthermore would tax dividends only once, in the hands of either the cor poration or stockholder but not both. Like a rationalized capital gains tax, this would amount to a tax reduction, but the improvement in rationality and ecient economic functioning would easily be worth the loss of a few billion dollars of revenue. Other capital taxes could make up the dierence. The shining jewel among the crowning absurdities of the American tax law must be, by acclamation, the progressive income tax. Even the name "progressive" is a bit of public relations propaganda, because it sounds like something forward-looking and therefore good when it really is no more than an attempted banditry of the rich few by the less rich many.

A

"progressive" income tax merely means a tax whose rate is not uniform at all levels of individuals' income. The American tax began at zero tax on the lowest incomes and rose to

70

percent of the highest incomes.

No feature of American tax was more questionable and less questioned than the progressive income tax. work.

Its cardinal failing was that it did not

There were so many loopholes that the rich simply did not pay

the highest progressive tax rates. The progressive tax produced very little revenue above what a uniform moderate rate would do. The progressive tax did spawn hundreds more pages of complexities of the tax code, either creating loopholes or trying to close them. It did give useless employment to thousands of tax lawyers and accountants, waste millions of hours of the best citizens' best eorts seeking to avoid the tax, and articially distort the use of resources by diverting them into less productive but less heavily taxed channels.

The progressive tax did weaken the morale of citizens

and strike most heavily at the moderate incomes of the middle citizens who contributed most to society but had least access to the means of tax avoidance.

The eects of the progressive income tax as compared with

a uniform rate of tax were all bad. progressive tax, made in

1845,

One of the oldest judgments of the

still held good:

The moment you abandon . . . the cardinal principle of exact ing from all individuals the same proportion of their income and

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30 American Taxes their property, you are at sea without a rudder or compass, and there is no amount of injustice or folly you may not commit. In the face of all the valid criticism, no reasoned defense of the progressive income tax exists. No need for a reasoned defense is ever recognized. The tax just feels right. As indefensible propositions go, the progressive income tax is a durable one. The progressive income tax is an economists' and politicians' tax. Peo ple who know better, like lawyers and administrators and taxpayers them selves, know it for a fraud. Economists, however, are prone to think more grandly about what they call "equity" in taxation, and to them it seems eminently more equitable that lower incomes should be taxed less than proportionately to higher incomes.

To them the progressive income tax

is an article of faith, and it is faith and not reason that perpetuates it. Equity is among the slipperiest of all philosophic conceptions. No compe tent ethical philosopher would dream of oering equity as a tape measure for economic calculations, but economists had no such compunctions. In practicing equity rather than economics, economists appeared to be prac ticing philosophy without a license, and practicing it rather poorly.

If

free markets are working correctly, and if income from inherited wealth is separately dealt with by suciently heavy inheritance taxes, the size of an individual's income is exactly proportional to his contribution to the rest of society, and it is dicult to see why a larger contributor is proportionately less deserving at the hands of society than a smaller one. As for politicians, the beguiling appeal of the progressive tax is easy to explain. The progressive tax was a feature of the rst income tax law of

1913,

and it was then an outgrowth of the softheaded Populist quackery

of the late lamented Nineteenth Century.

None of the other mad follies

of Populism survived into practice, but this one did. The rich should be soaked, it was thought, and the way to do that was by the progressive income tax.

Fortunately the soaked proved to be more nimble and eet

than the soakers. In nal analysis, the progressive income tax existed only as a political sop thrown to the hoodwinked masses. The obvious solution to the irrationality of the progressive income tax was simply to abolish it. The Federal income tax should be a at percentage of every dollar of every taxpayer's income of every kind. The amount of the tax would depend on the varying need for revenue and on the varying balance between capital taxes and income taxes, but the most desirable

164

range would probably be in the vicinity of

35

percent.

Taxes on higher

incomes would be reduced to this rate, and the rate is low enough so that inheritances and capital gains could be taxed as income. If the income tax were to be truly a single-rate tax, taxes on lower in comes would also be raised to this rate, and other concessions like personal exemptions and some personal deductions would be eliminated.

These

changes would amount to a tremendous tax increase of the order of a hun dred billion dollars a year, and the increase would fall on the vast numbers of lower incomes which benet from the most numerous votes and the most legislative solicitude. This tax increase would therefore be totally impos sible unless something else were done to compensate the smaller taxpayer for the tax increase. That something else is the national dividend which is to be proposed in the next chapter as a substitute for all government subsidy systems including subnormal tax rates and large tax exemptions. The hundred billion dollar tax increase represented by a uniform income tax contributes about half the cost of the national dividend.

Every low

er-income taxpayer who works would have more cash in hand, after the higher taxes on his income but supplemented by the national dividend, than without either. So long as this is true, no one need be shy of propos ing the massive tax increase of a single-rate tax. The uniform tax and the national dividend are pieces of a matched set. This shop does not sell them separately. Tax structure is the key to the enforced retirement of the ination tax, and the renovations that were necessary to the American tax structure were deep and wide.

They were deeper and wider than had been made

to the American tax structure in the previous sixty years of its life.

A

political realist might gasp at the assignment of doing all at a stroke what could not be done in sixty years of patching and xing. But it had to b done. There was plainly and simply no other way to disestab lish ination from the tax structure. Ination would gladly persist and wait until the plight became so intolerable that that kind of fundamental rebuilding was politically possible.

165

30 American Taxes

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31 Government Expenditure: the

National Dividend

The other side of the government's economic management from taxes is expenditure. What taxes draw in, and often more, expenditure must pay out.

The government never fails in this duty.

The task is easier than

drawing in taxes. The government nds myriad ways for getting rid of the surplus prots of national eort to someone, somehow.

The question of

this chapter is whether these ways are the best ways. Government expenditure is often falsely maligned, especially by conser vatives.

Government expenditure is no more innately evil or good than

expenditure by any other quarter of society.

It is true, as conservatives

say, that government expenditure tends to be somewhat more wastefully spent than expenditure by private persons; but it is also true, as liberals say, that expenditure on services that only governments can provide tends to be excessively niggardly in comparison with the overall auence of the American society. Most emphatically of all, government expenditure is not inationary of itself. The government could spend the entire gross national product without ination, if it contrived to tax away that entire product from its producers. Doing that would be bad for other reasons, but not for reasons of ination. Conversely, reducing the level of government expendi ture does no good whatever in abating an ination. Doing that merely cuts the supports from under a large number of Americans and leaves them in want, while the ination goes on. A stunning truth, seldom seen in clear view, is this: in the United States by the time of the ination, the primary economic role of the government had become to support the people by its expenditure.

No longer could

the government conne itself to providing the services that a government normally must perform, such as paying its soldiers and buying them equip ment, paying its judges and legislators and building them buildings, build ing highways and parks and providing schools and mails and railroads and

167

31 The National Dividend airports if no one else would. All these things the government must still do, but where once these were its whole job, now they were the lesser part of its job. The main objective of the government's expenditure was not to buy anything or build anything, but simply to give away purchasing power to help support consumption by the people. No one should lament the passing of the day when there was plenty to do for everyone who was willing, so that the government could justly leave everyone to fend for himself. It may well have been a better day, but that kind of attitude to it is ordinary nostalgia and is not constructive.

The

passing of that day is not a socialist plot, and the trend toward the gov ernment's supporting the people with its expenditures is a correct response to a plain necessity. The less urgently workers are needed to operate the system, while their need to consume is as great as ever, the more the gov ernment must draw taxes from capital and distribute freely to the people for consumption.

The truly conservative view would not be to deny or

deplore the necessity, both of which are futile, but to take care to see that the method of redistribution is well designed to increase and not diminish the ecient operation of the system. The American government had a patchwork of ways to give away pur chasing power to support the people, most of them masquerading as some thing else. They were similar to its patchwork of taxes. First there were the frankly gratuitous distributions which economists call "transfer payments," such as welfare payments, unemployment compensation, and Social Secu rity. Next there were huge subsidy programs like farm price supports and shipping subsidies. Next there was the vast amount of government employ ment, and private employment supported by government spending, which pretended to obtain a useful product or service but really was for the sup port of the persons employed.

Another form of distribution to support

the people was the government's inationary redistribution from creditors to debtors.

Still another was the income tax concessions that the gov

ernment gave to lower-income individuals through large exemptions and deductions and low rates.

Finally there were the articial legal devices

to prop up the prevailing wages in private employment, such as minimum wage laws, government-spending wage laws, and governmental support for the wage-raising powers of unions.

All of these were ways of channeling

purchasing power to the people. This collection of distribution schemes did the necessary job after a fash

168

ion, but as a distributive system it was uneven, unjust, ugly, wasteful, ineective, and actively destructive of American well-being.

It was obvi

ously uneven, because highly-paid administrators, capitalists, and workers in government-supported channels were handsomely kept, while multitudes of other citizens received next to nothing. because poverty still existed.

It was palpably ineective,

It was wasteful because programs were so

outlandishly complex that most of their expenditures were dissipated in administration. It was unjust and ugly because it was selective; the basic idea that some distributee must be allowed to spend some of the values that taxpayers have produced is less repugnant than the idea that some govern ment functionary should select the distributee.

Worst of all, the system

was actively destructive of the potential richness of American life because it purposefully prevented people from doing useful work that they would be glad to do. It is shocking to observe that payments under every one of the principal social programs  welfare, unemployment, and Social Security  were made on the one condition that the recipient refrain from working. Spurious employment inj government industry also precluded workers' do ing some other useful work, and articially high wage costs also directly prevented people from working. The existing distribution sys-tern did its best to make everyone idle as the intentional price of receiving its dole, and this was incredibly evil. It is incomprehensible how any nation could expect to grow and thrive by using all the surplus fruits of its eorts to induce people not to create any more. Suppose now, just suppose, that all of the government's existing dis tribution systems were swept away at a stroke and replaced by a single distribution system, masquerading as nothing but a distribution system, and beneting every resident American citizen equally whether rich, poor, old, young, able, unable, working or idle. The surplus prosperity of the na tion which was drawn in by the government through its appropriate taxes would be in eect apportioned among all the citizens, equal shareholders

1972, this national dividend might as a starter amount to a stipend of $1,200 per year to each adult and $600 to each child under 20. Later, as the system

in the commonwealth, as a national dividend. At the price levels of

began to work and to generate more surplus while dispensing with other government expenditure, the dividend might well rise considerably higher, but it must always remain modest in comparison with the income people earn by actively contributing to the society. This rationalization of all the

169

31 The National Dividend government's irrational distribution schemes into a single comprehensive distribution program, coupled with adequate capital taxes in place of in ation, would constitute the most momentous breakthrough the United States could make into the sunlight of the modern age. The theory of the national dividend is that the nation has surplus pros perity enough to take care of the most basic requirements of each of its citizens, such as food, clothing, housing, and medical care, with no further strings attached.

Attaching strings accomplishes nothing but to create

evils. So the government simply pays for these things. Beyond those most basic requirements which he has received free, every man is on his own and every man is treated exactly equally. He earns as much or as little more as he cares to work for, he is paid no more or less than the fair value of what he contributes, and he pays the same percentage of tax on whatever additional he earns as everyone else.

It is a two-tier system, admittedly

the purest socialism to the extent of minimum requirements, but also the purest individual enterprise for the much larger remainder of all activity. In comparison with the patchwork that preceded it, this system is even, just, and no longer ugly because all citizens share equally; it is no longer wasteful because its simplicity makes the cost of administration virtually negligible; it is eective because involuntary poverty should end; and it ceases to de stroy the potential richness of American life because it no longer restrains anyone from working who cares to. A national dividend as a general distribution system, coupled with an array of taxes including capital taxes, provides the government with a com plete set of valves to balance the ows between saving and consumption. If consumption is too high and saving too low, both the national dividend and capital taxes may be reduced. If saving is too high and consumption too low, as they were in the Depression, both capital taxes and the national div idend may be increased. If the people choose to work hard, the ows may increase; if they shirk, the ows must diminish. It is up to the people. The people control the total ows; the government just balances them. Even if capital grows so dominant as to eliminate all need for employmerit, the government can valve o from the fruits of capital, and distribute by the national dividend, enough consumption power to keep the system working smoothly. No other arrangement can do that. The cost of a national dividend would be apparently very high. By sim ple arithmetic, $1,200 per adult and $600 per child would appear to cost

170

the staggering sum of $212 billion, which was about national product in

1972.

18 percent of the gross

But the cost is only apparent.

The national

dividend actually costs nothing, because it constitutes no more than a re structuring of an existing patchwork of distributions that already cost just as much.

Let us emphasize the quid pro quo of the national dividend:

no more welfare, unemployment compensation, Social Security, farm sub sidies, shipping subsidies, other subsidies, income tax personal exemptions and deductions, low tax rates in lower income brackets, superuous gov ernment employment and government-supported industry, and legal props under the wage cost of private labor. Unless all these prices were paid, the national dividend would be unworkable. If all were paid, there would be no new cost. Social Security, unemployment compensation, and welfare were already costing $78 billion per year; subsidy programs were costing $25 billion; leveling the income tax at, say,

35

percent without exemptions or

deductions would yield perhaps $100 billion more per year; and the balance of the national dividend can easily be made up from increased capital taxes and reduced government expenditure in other sectors. The ways in which the national dividend could strike o the shackles from the American system are virtually limitless. People would be set free to do useful work again without forfeiting some government giveaway by doing so. Employment could once again be allowed to enjoy the fertility of a free market. Wages paid for work done could be allowed to nd the nat ural value of the work, rather than some inated level, without depriving any worker of his full share of the prosperity for which the national divi dend would be partly responsible. Valuable kinds of work that could not be economically done in the United States might be done again. Workers might come to look on great new strides in automation as a boon to their total prosperity rather than a threat to their livelihoods.

The national

dividend as a general subsidy to every kind of employment and activity would harness the nation's wealth to make it the strongest competitor in the world rather than one of the weaker. For the poor, a fund of buying power would be provided from which to nance housing, clothing, medical care, education, televisions, or whatever else they may desire most. The people themselves might decide what is of value, rather than the govern ment deciding for them.

Criminal convicts could help pay for their own

incarceration. Small farmers might be enabled to stay on their marginal farms against the tide of factory farming. Workers who had had to gravitate

171

31 The National Dividend to the grim cities for work or welfare might take their national dividends and disperse back to less lucrative but more satisfying surroundings. The magnet of urban welfare would be demagnetized.

Materialism itself and

the sovereignty of the dollar might be moderated. The citizen might choose to take some of the surplus prosperity in leisure rather than more work. The visions are innite. The idea of the national dividend is not althogether unknown.

Lady

Grace Rhys-Williams in England advanced the proposition of a universal "social dividend" with many sound arguments in her book, Something to Look Forward To, in

1943.

Milton Friedman's

1962

book, Capitalism and

Freedom, oered the proposal of a negative income tax as a replacement for the welfare mess.

Like any good enlightened conservative, Professor

Friedman was an advocate of simple, direct, and ecient remedies for ob vious problems. To the question of what should be done to help the poor, he would answer, "Give them money." The negative income tax and the national dividend are remedies of a similar character, but the more limited negative income tax seems too timid for the size of the problem. The national dividend does present a few serious problems of potential abuse.

One is the population problem.

An unlimited national dividend

would be an obvious inducement to breeding parents of a certain sort to turn out babies as a sort of cash crop. A national dividend which operated as a baby bounty would be worse than no national dividend at all. This problem is likely enough and serious enough that a workable national div idend would have to forestall it by paying no additional stipend for any future child which was, say, the third or later child of either of its parents, but instead carving out that child's rightful payment from his parents' existing shares. A second problem is that of incentives. It is the question of how people as a whole would respond to a national dividend. If they were paid enough for a decent minimum living without working, would they work?

Even

without a national dividend, dropping out of the system was moderately widespread.

Under a national dividend, it could not be less widespread.

The forces of necessity exact at least a little work from persons who are only marginally interested in working, and who might well lose that little interest if necessity were removed. The principle of the unconditional na tional dividend is that it is every man's own business if he chooses to drop out, and that it is both meddlesome and not worth the eort of the gov

172

ernment or anyone else to try to motivate him in some other direction, by withholding his share of the prosperity or otherwise. On the other hand, if everyone dropped out to retire on the national dividend, the surplus pros perity of the nation would quickly evaporate and so too would the national dividend.

There is still too much work to be done, day in and day out.

The day when no work is required is still far o. So the question still is, if there were a national dividend, would most people still work about as hard as ever in an eort to

1

improve upon the minimums provided by the

national dividend? What little evidence there is suggests that they would. Most people, including most of those the nation needs most, seem to work because it is their nature and not just because hey are driven by need. I do not underestimate this problem of the national dividend. It is the crucial problem.

If a national dividend would vither the will to work,

then a national dividend would not acceed. But if that is true, it is also true that there is no other vay for people to acclimate themselves to an overabundance prosperity. If it is true, people cannot cope with success. The people will be as great and grow as rich as they care to, ao more and no less. If the response to full prosperity is to cease trying and want no more, the people will decline. Granting the people a national dividend might let them grow vhen denying it will no longer make them grow. In the end, be people should be allowed to decide.

173

31 The National Dividend

174

32 Employment Of all the sacred cows of modern economics  among them interest, money, employment, investment, and growth  employment must be deemed by all odds the reigning bull.

All good economic performance is measured

rst by the fullness of its employment, and all bad performance by its rate of unemployment. All other economic consequences including ination are subordinated to employment. We are constantly being instructed about the "trade-o" that is supposed to be necessary between ination and unem ployment, so that neither can supposedly be reduced without an increase of the other.

As a consequence, we have both more ination and more

unemployment than ever before. Just as interest and money were found not to matter earlier, employment will be found not to matter now. (Investment and growth will have their turn later.) This is not to deny that employment may be something that everyone may need, but rather to say that employment could take care of itself quite nicely if it were simply allowed to take care of itself. Employment is not by any reasonable reckoning the ultimate end of hu man existence. Employment has two distinct aspects, the work done and the wages earned.

The economic system wants the work done, and the

worker wants the wages.

Economies' obsession with full employment on

behalf of the workers acts as if the main object of employment, even to workers, was the work. It is not; it is the wages. To a worker, the main object of employment is to gain access to the means of consumption, which is wages.

Work as having something to do may have a value of its own

separate from the wages, but to a worker that is secondary and he can quite ably ll that need for himself. In the simpler days of old, work and wages were insepara-, bly bound up together.

Work was the only known way of obtaining the means of

consumption, and on the other hand the economic system needed all the work it could get from its citizens in return for giving them the means of consumption. In the more modern day, employment and consumption are

175

32 Employment no longer completely inseparable.

The economic system has productive

power which increasingly exceeds the need for work. The system does not need and perhaps cannot even use all of the work its citizens can supply. The system therefore can and perhaps even must make some of the means of consumption available otherwise than in exchange for work done, which means otherwise than through wages. The national dividend, as a substitute for full employment policy, does this. It divorces the divorcible. It separates to some extent the distribu tion of the means of consumption from the wages for work done. It frees employment to perform no more than its natural function of getting done the work that must be done at a natural wage price, while letting people look elsewhere to the national dividend for a part of their total shares of prosperity.

Work is rightly the servant of men, and a national dividend

allows work to stay in that place; the enthronement of full employment as the sole source of all bounty, on the other hand, makes men the servants of their work.

When economic managers harness the people to articial

employment as the price of their purchasing power, they resemble kindly masters of pet dogs who relieve their pets of the desperate necessity to hunt and kill for their livelihoods but then will not give them their dog biscuits until the dogs have gone through some cute tricks that the mas ters like to see. Full employment policy, as the sole method of distributing adequate prosperity among the people, has a number of side eects, all of them bad. For one, it directly causes ination. For a second, it directly causes unemployment. And for a third, it directly causes stagnation. In order to distribute an abundant prosperity among the people, full employ ment policy must seek not only adequate employment but also adequate wages. Adequate wages in an abundant prosperity means unnaturally high wages, wages that are higher than the fair market value of the work done. Ination, unemployment, and stagnation are all caused by excessively high wages. It is paradoxical but true that the more eort there is to stimulate employment articially, the less real employment there is. Nothing could increase available employment more vigorously than to allow its wage cost to decline to a free market level. Ination results from high wages in full em ployment because money ination, itself the cause of price ination, is the only known stimulant strong enough to create work when excessively high wages do not permit a free market for work to exist. The trade-o which is alleged to be necessary between ination and unemployment (the so-called

176

"Phillips curve") is completely uninevitable. There is no necessary connec tion whatever. If there were a completely free market for labor, there could well be no involuntary unemployment whatever even while there was also no ination. Unemployment too is caused by nothing but unnaturally high wage lev els. If a prospective worker will accept a wage which is no higher than the fair value of the work he can do, he will be employed. The normal market response of a seller who cannot nd a buyer, including a worker who can not nd an employer, is to lower his price until he does nd a buyer. If a worker will not make this response in selling his work, he is voluntarily unemployed at most. Lord Keynes, be it remembered, dened full employ ment as the point where workers do not oer any more of their labor at the prevailing market price, not necessarily the point where all prospective workers are working.

Actual unemployment there might still be at this

point of full employment, because to a prospective worker the prevailing wage oered to him was too low to be worth foregoing his leisure, but if so the unemployment would be voluntary and not the proper concern of full employment policy. Stagnation accompanies unemployment and ination among the conse quences of unnaturally high wages. The higher wages rise in order to pro vide workers their fair share of prosperity, the more useful work prices itself out of existence. The workers suer from lack of the work and wages, and that is unemployment. The system also suers from lack of their produc tive eort, and that is stagnation. As the nation grows richer, one by one the most useful and worthwhile  but not lucrative  activities can no longer be carried on in the nation.

The nation cannot let its wages fall,

lest many of its people not share in the richness. But it cannot get work done, because the wages are too high. A paralysis of auence sets in. The nation nds itself so rich that it cannot allow itself to work. The nation reposes on its collective posterior in order to keep its auence up. It is pre posterous. And it is all because the wages of work are relied on exclusively to distribute the surplus prosperity as well as to pay for the work. A nation in this predicament is living on its capital in the truest sense, because it is the capital investment accumulated over past centuries, which could never be accumulated again, that makes all this possible.

It is

grotesque that there should be any unemployment, any stagnation, or any spurious employment, all cultivated by full employment policy, when the

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32 Employment needs for useful work confronting the nation are still enormous. There was no shortage of work to be done in the United States. The supply of workers exceeded the need only in relation to the useful work that the nation was doing. In relation to what the nation could be doing, there was plenty of useful work for everyone for decades to come. Whole cities of slums waited to be pulled down and replaced with decent housing. Decrepit transporta tion systems ached to be restored.

The building of complete pollution

systems for every city, town, mill, and factory could engage every available worker. In fty years, perhaps, the work might run short, but not sooner. If there were a free market in labor, all these things I could be done. Only by shaking o an indolence enforced on the nation by the inated wages of full employment policy could the work be allowed to begin and employment to become truly full. A free market in labor means simply that the wage cost of labor is set purely by supply and demand for workers, without articial inuences like wage laws, unions' manipulation, or restraints on the supply of workers. If the supply of workers is large and the demand for them is moderate, wages must be moderate and a competition among workers may develop. A free market in labor, something that had not been seen in the United States for at least forty years, would be the complete remedy for all problems of unemployment and stagnation. Not for ination  capital taxes take the place of that  and not for adequate prosperity  the national dividend must help with that  but for all the remaining problems of work for the workers and productivity for the nation. A free market in labor might well lower the average market price for labor, but the combination of lower free market wages and the supplementary national dividend would improve the total lot of every worker of the nation over his lot with unnaturally high wages alone. The national dividend would maintain fully his share of the prosperity, while he in common with all other citizens would participate in the renewed richness of the system which free market wages and employ ment made possible. What would happen, if there were both a national dividend and a free market in labor, would seem to be this: Wages might be lower, but total prosperity of everyone would be higher. The lot of workers could easily be so much improved that they might voluntarily choose to work shorter weeks with more leisure rather than earn more. Automation could be welcomed for its further improvements in the national dividend, rather than feared for

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its losses of employment. If there were no more money ination, wages must remain not only lower but constant. No law or government authority would decree that they remain constant, but both prices and wages simply could not be raised in the market if there were no more money.

The biennial

strike for higher wages would be futile, and it might as well not occur. Because of increased competition among the less skilled kinds of workers, it would be wages for unskilled work that would be lower, but wages for the scarcer skilled kinds of workers probably would not be any lower. The incentive to workers to improve their skills so as to get better jobs would increase, and the chronic shortages of skilled workers might abate. Even in unskilled work, wages could not fall far; employers setting wages would be competing against a somewhat reduced need of workers to work, because of the national dividend, and that is a more humane competition than against the brute force of unions but equally eective to keep wages up to presentable levels. In a free labor market there would be no involuntary unemployment  none. Some workers might unemploy themselves because they did not like the wages or the work, but that would not be unemployment. No man is involuntarily unemployed while any job is open, anywhere, at any wage, that he could perform or learn to perform. The purpose of a labor market is to adapt the available workers to the available work by inducing the unemployed to move, to take the available wage, or to retrain themselves, and the motive force causing the market to function is that the worker's only alternative be voluntary unemployment.

So long as the voluntarily

unemployed are not impoverished, because of the national dividend, the market can be allowed to operate on its own. Although there would be no involuntary unemployment, there might well be considerable dissatised employment, which means workers who did not unemploy themselves but still were not satised with the wages or the work. This too makes a labor market function, because it impels the dissatised to improve themselves as workers for the better jobs, and it impels the workers already in the better jobs to improve themselves too in defense against the dissatised candidates outside. This kind of competition is not altogether enjoyable, but it makes the system go and over the centuries it proved to be endurable. The free market in labor nds blocking its way, like the glowering ranks of the Philistines, the whole institution of labor unions.

Unions are the

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32 Employment principal reason why free markets in labor do not already exist.

Unions

are dedicated to no one principle so much as the extinction of free mar kets in labor.

Competition among workers is the cardinal anathema to

the unions' theology. Unions routinely engage in anticompetitive practices which, anywhere else but in labor relations, would win them long prison terms under antitrust laws. Unions' commission is, after all, to raise wages higher than their market value, and like any good market-rigger they do that by eliminating competition from the market in any way they can. The ways that unions use are familiar. Union contracts suppress compe tition between one worker and another by equalizing wages and by exalt ing seniority over all other qualications. They inhibit better workers from working better than other workers. They restrain the amount of work done and increase the number of workers required, which is known as featherbed ding. Unions often regiment entire industries so as to eliminate competition between the workers of one employer within that industry and those of an other. Employers in the industry often happily participate in this process so as to help eliminate at least that aspect of competition among themselves. Unions restrict, often by simple fear, the entry of hungrier new workers into an industry which is on strike or which they monopolize, as in construc tion or longshoring. Unions resist the introduction of more ecient uses of labor or the movement of industry to more economical labor areas. All of these things suppress free markets in labor. They restrain competition, increase cost, and make industry less ecient. They cause unemployment and stagnation.

They make the total pie divisible among all the people

smaller than it otherwise could be. The theory of these methods, if there is any theory, must be that they gain workers larger slices of the smaller pie, and supposedly that is better for them than merely fair shares of a larger pie. That theory is disputable. Of course the continuing crusade to eradicate free markets in labor is never wholly won, or even predominantly won. The surviving vitality of American industry attests to that. The native industriousness of workers themselves springs up persistently despite all eorts to keep it down, and some unions too are less union-like than others. But the fact remains that the least healthy industries are those in which unions have most nearly succeeded in extinguishing free markets in labor. Unions' eorts to extinguish free markets have the direct aid and comfort of the Federal government, without which they could not prosper. Far from

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seeking to foster competition as it does in industry, the government silently supports and assists the unions' eorts to suppress it. Most of these forms of assistance are traceable to unfortunate meaures adopted by President Franklin Roosevelt's administration to try to cure the Depression. They were generally ineectual for that purpose but left the nation's economic system loaded with labor shackles for the ages to come. One form of assis tance is the various minimum wage laws, such as the Fair Labor Standards Act, the Davis-Bacon Act, and the Walsh-Healey Act, which, like every eort to dictate prices to a market, succeed only in drying up demand for labor and creating unemployment. Another form of government assistance is the millions of jobs of spurious employment engendered by the govern ment's spending, which produce nothing but reduce the supply of labor and inate its cost. The most important form of assistance is the govern ment's commissioning the unions themselves as a kind of fourth arm of the government, through mainstay laws like the National Labor Relations Act and the Norris-LaGuardia Act, to act as the government's own regulatory agency imposing discipline and fair labor conditions on industry. This is ingenious.

The government's laws are hands-o laws, meaning

that they do not so much abet the unions' regulation as forbid governments, courts, and employers from interfering with it. With the help of this kind of law, unions can regulate very eectively. Unions are possibly the most ecient of all government regulatory agencies. They regulate not by the tedious government methods of hearings and regulations and injunctions, but by the more instant and muscular methods of strikes and boycotts. With these tools, any government agency could probably regulate eciently too. These laws are not bad laws in principle. The government should indeed keep hands o labor disputes between an employer and its own employ ees. Employers should indeed be prevented from interfering with their own employees' organizing into unions if they wish.

But that is as far as it

rightfully goes. There should be no way for unions to bring the weight of the labor side of a whole industry to bear on one employer or on all the employers in that industry. There should be no way for striking employees of one employer to call in the coercive support of anyone else. There should be no way for unions to monopolize employment in any industry. Expert hired representatives, unions may properly be; brokers of hired power, they should not.

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32 Employment Labor unions are a complex and mixed subject. The institution of unions is not all good and certainly not all bad. Unions contributed mightily to the strengthening and perpetuation of American industry by equalizing the two equal partners, capital and labor.

They still contribute a legitimate

service as a kind of professional adviser to workers. Unions have earned an honest place for themselves, but they have not proved themselves any more t to act as a fourth arm of the government than industrialists are. Unions are not the same thing as their members. Workers working are among the most deserving of all citizens, but unions militating on their behalf are not necessarily so. One thing that labor unions are not is farsighted. They do not grasp sophisticated notions of the well being of workers, such as the idea that other things might be indirectly better for workers than articially high wages.

Unions do not represent the interests of workers rst and

unions second if they are dierent, as they would be if the wages for work were to lose part of their function of distributing prosperity. Unions still adhere to simple-minded philosophies like the famous "More!" of Samuel Gompers and the view of workers in society as an eternal war between Us and Them. Both kinds of view are anachronisms. Unions have too fond a taste for anachronism. Employment is not really a dicult technical problem. A free market in labor would solve it, and a free market would spring back into existence if the government merely released its restraints. Given a free market, full employment is as easy to provide as the useful work that needs doing is abundant.

A free market in labor would go far to restore the American

nation to its former strength, health, and ability to grow. Coupled with a national dividend, it would generate a greater prosperity shared fairly among everyone.

Conversely, the kind of labor mentality that regards a

free market with the ultimate loathing is the blank wall that bars the way. A free market in labor, once gone, does not come back easily. No one knows whether people ever would permit it to come back once labor unions and labor mentality had driven it away. In this section of the book, we are indulging the luxury of ignoring practical possibilities. that says a free market in labor must come back. without it; not well, but it can do.

There is nothing

The nation can do

It is not a matter of life and death,

but only of more prosperity or less, more employment or less. Intransigent labor can continue to demand an ever-larger share of an ever-smaller pie, until in the end it owns the entire share of an empty plate. That is exactly

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what it will do if it decides that even that is better than the terrors of a free market.

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32 Employment

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33 Investment and Growth If employment is the sacred bull, investment and growth are the sacred calves of modern economics.

If employment is what economists try to

achieve, investment and growth are how they try to achieve it. Investment is undeniably the cornerstone of all economic development. Investment is what built the industrial system, and investment is what made the system as fruitful as it is for the people who inherited it.

In

vestment in this sense means the formation of capital, and that in turn means using some of the product of men's labor to build physical produc tive assets instead of consuming the output as it is produced. A primitive farmer, for example, who spent some of his scarce productive time building a water wheel to grind his corn more eciently, or building a plow to plant it more eciently, or building a fence to protect his corn from animals, was infesting. He was forming capital. His allotting some of his total time to investment instead of just to producing corn was economic saving. In vestment was the opposite of consumption, which was what he did with the corn he grew. The more eciently his capital helped him grow corn, the more corn he could grow, and that was growth.

And the more his

production was increased by investment, the more production capacity he had in excess of the requirements of subsistence so that he could grow still further. Or, on the other hand, the more capital investment he had made the less he would have to work to produce an adequate total output. Investment is unquestionably a good thing if it is good investment, and growth is unquestionably a good thing if it is good growth.

In the old

days, when each primitive farmer was allotting his own productive time between output for consumption and output for investment, the sacrice of time to investment tended to be rather shrewdly chosen. As a result, the investment was mostly good and the growth was mostly good. In the latter day, investment and growth are elected not by either produc ers or consumers, but by governments and economists. Modern economics turned the whole chain of goals upside down.

It made the object of the

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33 Investment and Growth whole economic game not sucient production, but sucient employment. It said that no longer does man work in order to produce, but man pro duces in order to work. It said that man must make capital investment not so that he can work less, but so that he can work more. Only a professor could persuade himself of the truth of such sophistry. The pivotal tenet of the modern economics is that investment of any kind, good or bad, produces more employment (the "multiplier") than is spent on the capital investment itself. The more investment of any kind there is, the more employment there will be. This makes of investment no longer a means to a desirable end, but an end in itself. That is in-vestmen tism. This transforms growth also from a desirable objective to a necessity. That is growthism. In pursuit of these goals, modern economics is willing to resort to all manner of distortive devices to encourage indiscriminate investment.

The principal one is articially low interest rates, which do

encourage investment because larger numbers of investment opportunities will have prot margins higher than the interest rate and therefore attrac tive for borrowing and investment. Since articially low interest rates can only be obtained by money ination, investmentism translates itself into inationism.

What little thought economics gives to the design of taxes

concentrates itself, not as it should on the balance between capital and consumption, but on what tax devices will articially stimulate investment and therefore employment. The misbegotten tax investment credits of the ination era were an example. The result of the economists' obsessions for investment and growth was not outright failure, strictly speaking. There was investment and there was growth. The percentage gains in the gross national product did continue to ow in as numbers on paper. But a kind of Gresham's law operated  bad investment drives out good  so that what investment there was was not merely indiscriminate but mostly bad. Bad investment means the building of superuous factories, oce buildings, oce equipment, airliners, and highways, even while urgent needs for other good investments like houses, pollution facilities, and transportation systems go unsatised. Bad growth means constantly increasing production merely for the sake of production and not for the sake of satisfying the wants of people.

No one person's

opinion of what investment and growth are good or bad is valid. The peo ple and the entrepreneurs would decide that, voting with their purchasing power. Good investment and growth are denable as whatever investment

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and growth would remain if all articial stimulants by the government and economists were removed. Even if investment and growth were all good, their fatal aw is that they cannot continue to innity. Investment and growth are inseparably accompanied by a growing permanent destruction of irreplace able resources, by a growing permanent creation of indestructible wastes, and by a growing permanent propagation of insatiable populations. In the far distance, the point waits where no more investment or growth can be tolerated. If an economic system supports itself by relying exclusively on articial investmentism and articial growthism, it is sure of eventually reaching the point where it cannot support itself at all. Investmentism and growthism clearly have a limited life, and the economic system that ties itself to them will have a limited life too. A slavish commitment to investmentism and growthism is a belief that an economic system cannot live without growing. That is as plainly false as to say that a man cannot live without being young. Investmentism and growthism are a refusal to let maturity arrive. They are a quest for eternal youth, and they are as neurotic and futile as such quests always have been. Economic youth, like any other kind of youth, may have been an exciting time of building and looking ahead, but maturity is said to have its rewards too. None of this is to say that the economic youth of the United States was necessarily over and past, but rather to suggest stripping away all the articial youth to see what real youth there might still be, or what real maturity might quite pleasantly take its place. An extra word or two about population growth is in order. The disas trous future consequences of unrestrained population growth were at last being noticed in the United States.

Restraint of population growth was

being urged even at the same time that economic growth was being stimu lated, often by the same people. The two goals are irreconcilable. Economic growth is heavily dependent on population growth. If population growth actually slowed down, growthism would be more dicult to pursue and full employment impossible to achieve. An expanding population growth produces more consumption, which the system needs, than workers, which it does not need. Hordes of babies and children consume loyally but they do not work. The reverse would be true if population growth slackened. All those hordes of former babies and children would then need work, but for scarcity of new babies and children consumption would fail to increase.

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33 Investment and Growth The problems of insucient prosperity of the past were as nothing to what would come if population growth did indeed abate. Employment, invest ment, and growth not only are not friendly to stabilization of population but probably could not either endure or survive it. One side in this conict must yield. Fortunately, the same device that sets employment free also sets in vestment and growth free.

The problem never was employment, but an

adequate distribution of purchasing power.

If employment was not the

problem, then articial investment and growth were not needed to provide employment. If adequate distribution of purchasing power were provided by a combination of capital taxes and a national dividend, in addition to wages for work, then employment, investment, and growth could all be set free to go their own way. And a better way it would be. As was true of employment, the less eort there were to stimulate investment and growth articially, the more good investment and real growth there might be. If there is purchasing power in hand, people will buy what they want, grow as they wish, and invest as they need to. Purchasing power begets its own employment, investment, and growth. What it begets is good by denition, because it is what the people elect, having at their disposal the means to choose. Risk takers can best decide what risks to take, investors what in vestments to make, people whether to grow, and workers whether to be employed. No wealth and no prosperity was ever manufactured in the of ce of an economist or a bureaucrat. They spring only from the eorts of the people.

Economists and governments can best conne themselves to

providing the people the freedom to choose, and, having done that, they will have done well.

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34 Dogma Dogma is the mummied form of theory.

Dogma consists of tenets of

mind that have ceased to grow and adapt. Dogma is living belief become petried, working theory become embalmed in stone. America was shut into its ination by formidable walls of dogma on every side, as high and blank as a sierra.

One wall was conservative dogma.

Another wall was liberal dogma. Still another wall, the most formidable of all, was economic dogma, which was the mummied theory of the very profession which was trusted to know the way out.

Among them, these

dogmas eectively closed o every avenue of escape from the American ination. For probably as long as men have consorted with other men, they have divided themselves naturally into two irreconcilable camps corresponding to what we nowadays call liberals and conservatives. The liberals at Athens, for example, were those who favored conciliation with Persia or Sparta, and at Rome they favored uplifting the poor from their poverty with bread and circuses. Conservatives thought all that futile. Never in history have liberals and conservatives compromised their dierences appreciably, and they probably never will. The problems of the ination stood as close as it was possible to stand to the center of the conict between the warring camps.

The questions

of who shall be taxed, who shall benet from the government's largesse, who shall work, and who shall benet from work were their main line of battle. It is not dicult to predict which of the ideas this book advances would be embraced by liberals and which by conservadives. Liberals would adore, and conservatives abhor, the massive new capital taxes, inheritance taxes, net worth taxes, and capital gains taxes, and the massive new dis tribution system through a national dividend. Conservatives on the other hand would celebrate, and liberals denigrate, the abolition of upper income tax rates, lower income tax rates, income tax exemptions, double corporate taxes, welfare, unemployment compensation, Social Security, government

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34 Dogma subsidies, articial employment, and legal supports for unions' restraints of trade. Virtually every member of both camps would embrace about half these measures. Hardly anyone would embrace them all, though the fact is that none should be adopted unless all were. In the eternal stalemate between the two camps, it is better that nothing be done than that either camp prevail. The conventional liberals and conventional conservatives who inhabit both camps are essentially impostors. They are not true to either liberal ism or conservatism. They are usurpers of their own names. The words themselves, "liberal" and "conservative," are both good old words, they are both names of commendation, and they entail no necessary conict with one another.

"Liberal" connotes liberty, liberality, abundance, and

progress, and who could condemn any of those? "Conservative" connotes conservation, frugality, and mindfulness of the future as well as the present, and those traits too are laudable.

Both conceptions in their true form

could easily coalesce upon policies of maximum present municence con sistent with permanent continuation of that municence into the future. Half of that idea is foreign to conventional liberals and the other half to conventional conservatives. Individual men who stood tallest in history often could not be readily classied as either liberal or conservative.

They were both liberal and

conservative in the true sense, but neither liberal nor conservative in the conventional sense.

They seldom had many close followers.

They were

dwellers in the no-man's land between the two camps. No liberal is a true liberal who is not obliged to admit also being conservative, and conversely, and the conventional members of both camps were of a purer and therefore falser strain. The conventional conservative gives his camp a reputation for not only conservation but parsimony. He conserves for the sake of conserving, and he resists change for the sake of sterile stability.

He acts according to a

belief that whatever is, is right. He speaks usually in defense of some kind of vested interest, such as existing wealth or entrenched power, and he opposes any kind of progress that would be hurtful to those vested interests. He tends to show a lack of humanity toward less able and less fortunate people. He insists on natural selection by individual accomplishment in its uttermost rigor, especially for other people. He is too fond of laws to repress the natural forces that actuate other people which he considers ignoble.

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By the time of the American ination, the conventional conservative had become an endangered species.

His numbers were reduced and his

strength had waned. This decimation of the conservatives was itself a dan ger, because, like the pest that keeps other pests under control, the militant conservatives had long kept the militant liberals trimmed in numbers and cowed in audacity. If one kind dies o, the other will multiply, and multiply was what the camp of the liberals had done. What passes for a liberal in modern times is a complex fellow. He clothes himself in the raiment of generosity and love. His motives are of the purest and his goals of the loftiest. He seeks to benet his fellow men. He concerns himself, for the most part sincerely, with the weaker and less rcessful of so ciety's members. No one but the harshest isanthrope could really quarrel with a liberal's objectives, ut beyond the purity of his motives and the altitude of his als, the conventional liberal ounders. If softness of heart his virtue, softness of head is his aw.

He can be counted upon to fol

low all the worst-conceived, least ecient, most costly, and most wasteful routes toward his goals, generating malignant side eects, breaking down the fruitfulness of the system, doing great harm to the objects of his own benevolence, and nally failing to reach the goal itself. A liberal's benign goals, if they are achievable at all, are invariably Achieved most eciently by hardheaded conservatives. A conventional liberal is congenitally unable to count the cost, feeling perhaps that it would seem mean of spirit to look at anything so crass as the price tag when a humane goal is in view. He labors under a. quixotic belief in the perfectibility of life, scorning mere improvability.

He is an

activist, but his headlong activism is akin to the brillation of a diseased heart, while it is the slow and plodding beat of a healthy heart that moves the good fresh blood. He too trusts naively in the magical ecacy of mere laws to generate and guide natural forces, resembling nothing so much as King Canute decreeing that the tides of the sea be still and sending his royal bureaucrats to og the waves when they fail to obey. With his exclusive concern for all those who nish out of the running in the footrace of society, the common liberal is in constant peril of making a cult of inferiority and a !stigma of excellence. Any society which exalts inferior over Superior, cultivates its most barren elds ahead of its most fertile, and reserves its best prizes for anyone but its best contributors is in deep trouble as a going society.

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34 Dogma With his eort to elevate altruism as a ruling principle beyond the re quirements of humane charity, the common liberal introduces a disorganiz ing force into the operation of society. The society which is most liberal for everyone is that society in which every member is induced to contribute the most he is able in exchange for the maximum possible gain of income to himself.

The liberal's altruism deprives society of the eorts of both

himself and his distributees. The conventional liberal loves too well to meddle in the lives of others. He is allergic to individual liberty.

The last thing he wants is to set up

his fellow men on their feet and let them nd their own way. He wants to hold their reins, like an overprotective parent. And like such a parent, he usually harms more than helps his dependents. The ordinary liberal is usually several steps removed from real life. That is how he can be so foolish. He is almost always either wealthy, or academic, or artistic, or political, or in some other way has escaped from the need to do productive work for a living. Workers are often allied with liberals for their own gain, but they are seldom liberals themselves. As more and more of a society's members become removed by auence from direct exposure to the sweaty production of wealth, the society's most urgent task is to preserve an instinctive memory of what the sources of that wealth were. Liberals fail to remember. Most troublesome of all, the conventional liberal suers from great di culty learning. His beliefs are impregnable. He is impervious to evidence that his best-loved schemes mostly cost too much, backre, and fail. His defense is simple and complete. He denies the evidence. That is the way of dogma. John Maynard Keynes once wrote a plaintive article entitled, "Am I A Liberal?" In it he looked about him in England and found no party t to join. The Tories were diehards. Labour were a party of class aggression. The old Liberals were moribund.

Dogma was on all sides, and reason

nowhere. It is the same with Republicans and Democrats, or indeed with all parties of every land in every age. Keynes' conception of an individual capitalism continuously working itself lean was congenial to hardly anyone. Keynes expressed it this way: The Conservative Party ought to be concerning itself with evolving a version of Individualistic Capitalism adapted to the progressive change of circumstances. The diculty is that the

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Capitalist leaders in the City and in Parliament are incapable of distinguishing novel measures for safeguarding Capitalism from what they call Bolshevism.

If old-fashioned Capitalism

were intellectually capable of defending itself, it would not be dislodged for many generations. Some years later, in

1939,

he said this:

I am ever more convinced that there was deep wisdom in those seventeenth and eighteenth century thinkers who discov ered and preached a profound connection between personal and political liberty and the rights of private property and private enterprise. The fact that the lawyers of the eighteenth century perniciously twisted this into the sanctity of vested interests and large fortunes should not blind us to the truth that lies be hind. As Count Kalergi has recently reminded us, in all ages private property has been an essential element in liberalism, a bulwark of personality against the omnipotence of the State, and a stimulus to seek comfort and culture, and it was recog nized in the French Revolution by the seventeenth paragraph of the Declaration of the Rights of Man as an inviolable and sacred right. Keynes was a dweller in the no-man's land between the liberal and conser vative camps, a highly unpopulated place. To be on the right track, one must dwell there too.

One must learn to like the solitude.

Being alone

is perhaps no assurance of being right, but having plenty of company is a fairly strong suggestion of being wrong.

America's challenge in the in

ation was to take the scarce best from the dogma of each camp, leaving the copious dross behind, and then to blast a breach through the walls of dogma to open a way beyond them. Economic dogma was an even more formidable barrier in the American ination than the dogma of conservatives and liberals. After Keynes, dom inant economic theory had taken an increasingly mummied form.

The

American ination was an economists' ination, just as the German in ation had been. Learned economists were given their head as they had seldom been given before, and the direct result of what they learnedly di rected was disaster. The direct result of what they deliberately chose to

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34 Dogma do was the ination and nothing but the ination. No command post in the whole directorate of American life was more vital than the economic command, and none was more poorly served. If economists had performed half as creditably as the industry and labor against whom they loved to ponticate, America would have been blessed indeed. In the face of its own failure, economic dogma remained serenely un changed. Dogma is like that. At the crest of their own ination, the eco nomic priesthood were still nodding and polling themselves and ngering their talismans and murmuring their incantations of employment, invest ment, and growth. Their assignment was still what it always was, or should have been: let everyone work who wishes, let everyone have a fair share of the prosperity, cheat no one, and let there be no ination. The priest hood and their dogma were still failing in that as completely as ever. They showed no awareness of what had happened and no idea of what to do next. As experts, they appeared not to know what they were doing. Strangest of all, their sorely tribulated ock still listened to them as respectfully as ever. Prevailing American economics had degenerated since Keynes from a live and developing science to a kind of witchdoctor sect. It was like medicine of the day when George Washington's physicians had all but bled him to death before he nally asked to be allowed to die unassisted. It was like geography of the day of Columbus, when the idea that the earth was at was the dazzling New Geographies and the much older orthodoxy of the round earth was virtually discredited. It was like physics in the days of the quest for perpetual motion, but alas, the conservation of energy still held economics in bondage too. The aberration of the New Economics in America bore perhaps the strongest resemblance to the Lysenko aberration in the agriculture of the Soviet Union. Trom Lysenko was the ocial genius of plant genetics in the governments of Josef Stalin and Nikita Khrushchev. He nailed ocial Soviet agriculture to a set of his own revolutionary theories that promised miraculous and eortless gains in crop yields, just like the gains in economic abundance promised by the New Economics. Unfortunately for Russia, Ly senko was a mountebank, an honest one perhaps but still a mountebank. His theories failed and so did the Russian crops.

Only after the mighty

eort of expunging the Lysenko aberration completely could Soviet agricul ture return to the sweaty and unmagical work of hewing out real gains. So

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too with the New Economics. Milton Friedman was fond of quoting an aphorism attributed to Poincare, the French president, that war is too important to be left to generals. Pro fessor Friedman adapted it to say that monetary policy is too important to be left to central bankers. It is equally true that economics is too impor tant to be left to economists. Even generals can bungle their commands without consequences as dire as if economists do, and few generals ever bungled as purely as economists did in the American ination.

What is

true of generals, central bankers, and economists is perhaps true of every other species of experts as well: government is not safely left to politicians, law to lawyers, education to educators, or information to journalists. An expert has devoted himself so exclusively to probing all the thickets in his own forest that he understands less well than an intelligent outsider where his forest ts into the landscape.

He is no blinder than anyone else, he

just looks that way. A rare man can overcome this handicap, but only a rare man. An expert may not necessarily be unt to preside over his own domain, it is just more dicult for him. A rare general is t to assume the ultimate responsibility for war, too. The rare economist who can assume it for economics can do so not because of his expertise but in spite of it. Economists are only men, after all. They are good men and true, one and all, and each one undoubtedly desired the good health of their patient, the American nation, fully as ardently as George Washington's physicians desired his.

Economists are all intelligent men too, better able than av

erage citizens to apply dicult and sophisticated conceptions which they receive from elsewhere. But when something goes awry with the received conceptions, the average intelligent economist is not enough to set them straight. The mind capable of original creation is as rare as it ever was. All the doctoral degrees in Academe do not necessarily add up to a single such mind. Economists seem susceptible to catching various occupational contagions which impair the eectiveness that they as individuals otherwise would have. Being academic, they suer from the same insularity from the rigors of real life that liberals do.

Economists often sound as if they thought

employment and unemployment were something that comes in bottles, like tincture of iodine, to be mixed up in a laboratory beaker and applied as needed.

Plying a shovel out in the economic ditches with the rest of us

might be good for that ailment. Economists are in the constant scholar's

195

34 Dogma danger of over-rening their material to a pile of ne dust, learning more and more about less and less until they know everything about nothing. They develop a liking for paradox and a love for making problems look more dicult than they really are, the better to justify their experthood. Economics is swept by a constant epidemic of mathematics, substituting equations for ideas and computers for brains, as if mathematics lent sci entic legitimacy to the black art.

Many an economist, deprived of his

mathematical language, is speechless. Struck on the head by Newton's ap ple, he would probably consult his computer to discover that apples will almost invariably fall outward into space, except on very rare occasions, predictable by enormously complex computer calculations, when they will fall downward instead on unguarded heads. Playing with their computers, economists too often develop a disturbing taste for playing with the levers that operate the lives of other people. Their charming name of "model," a computer term, aptly describes their conception of the rest of us, like a transcontinental toy train set complete with cute little gures that move about at the press of a button just like real people. Economists are not all of one mind, let it be said. Economists disagree among themselves as sharply as most men. Many a good economist knew better than economics as a whole did in the American ination. But dissent was too scattered and too polite. Denunciation is a mode of expression that is not often used within the cloister, but nothing less than denunciation of the old dogma could make it known outside the cloister that a priestly doubt existed. Laymen cannot cogently denounce experts, and if experts will not, error will persist. If experts shall lose their expertise, wherewith shall they be expertised? The fact that only the rare economists can be entrusted with economics is not reason to discard economics, but to go and nd the rare men. Milton Friedman regularly advocated a government of rules instead of men in economics, as a solution to the deciencies of men.

But rules are not

superior to men; they are no better than the men who make and observe them. The remedy for a defective government of men is not more rules but better men. The death in

1928

of Benjamin Strong, the dominant central

banker of the United States, dissolved the shrewdest economic government of men (with Norman of Great Britain and Schacht of Germany) that existed in the twentieth century, and perhaps caused the Depression and later war. The remedy for the death of a man like Strong was to go and

196

nd another. American economics in the ordeal of the ination left much to be desired, but for the same reason left much room for improvement.

The tremen

dous forward strides which were already past in sciences like medicine and physics were still ahead in economics. The assignment was still the same, no one had changed the specications: let the people prosper, nd a stable cruising speed, cheat no one, and permit no ination. In a nation still as strong and as rich as the United States, the assignment simply could not have been as impossibly dicult as economists made it look. The problem was not the impossibility of the task, but the incapacity of the men who had thus far tried it.

All that economists needed was someone to show

them how. Lord Keynes once said, If economists could manage to get themselves thought of as humble, competent people, on a level with dentists, that would be splendid! And if economists as dentists could manage to stop agonizing over the metaphysics of toothache and just learn to drill the blooming thing, that would be splendid indeed!

197

34 Dogma

198

THE LAST ACTS: The American Prognosis

199

35 Act Two, Scene One:

President Nixon Begins

I can remember, as a student, being taught the structure of a well-wrought traditional stage drama as an inverted V form. After a prologue or some other prefatory material, the ow of the drama was supposed to turn up ward and rise steadily to a turning point, which occurred almost unnoticed somewhere in the second act. After that, the action was to turn downward and proceed equally steadily to a nal denouement which was to occur near the close of the third act. In this design, a good ination is something like a good play. The administration of President Richard Nixon, beginning in

1969, clearly

embraced the second act of the great American ination which had been initiated years earlier under President Kennedy. It might well encompass the third act as well, but the second act clearly. Richard Nixon was predictably a dierent sort of president from his two predecessors who had presided over the earlier formative stages of the in ation. He was a Republican as they had been Democrats. He had been vice-president as part of the Eisenhower administration, which itself had constituted the last years of stability before the renewed ination; began. And Mr.

Nixon had failed by only the narrowest of margins to win the

presidency from Mr. Kennedy in of Mr.

1960.

It was foreseeable that the attitude

Nixon's administra-, tion toward the inationary mess would be

altogether dierent from that of the Kennedy-Johnson regime.

By both

temperament and philosophy, President Nixon and the Republicans were well suited to try to rectify the terrible inationary damage, some of which the Democrats had already done and the rest of which they left waiting to happen. In this eort, however, the Nixon administration failed.

It proved to

lack the wit to know what needed to be done, the will to do it if it had had the wit, and the power to do it if it had had the will. After years of

201

35 President Nixon Begins the mightiest eorts the presidency could bring to bear, the nation had nothing but a recession and some hard times to show for its pains and had gradually grown weaker and more vulnerable than President Johnson had left it.

Both the current rate of price ination and, what is more

important, the Index of Latent Ination were higher by had been in

1969.

1973

than they

All of this meant that the sternest measures of this

sternest of presidents had achieved no forward progress at all against the ination, but at best had only held the line and succeeded in losing ground more slowly. To say that President Nixon failed is no great criticism of Mr.

Nixon

himself or his administration, for the task that confronted them in

1969

was one that demanded economic skill bordering on genius. Genius merely failed to appear.

It was a far more dicult task than would have con

fronted Mr. Nixon in The United States in of rm stability.

1961 1961

if he had won election to the presidency then. had no serious economic problems and a base

By comparison, the challenge of

1969

was the severest

economic challenge faced by any president since President Roosevelt tried, with equally scanty results, to meet the challenge of

1933.

Mr.

Nixon's

failure was a failure to subdue a monster that others had bred and raised to full maturity. Measures like those of Mr. Nixon would have been quite sucient in

1961

to forestall the birth of monsters.

The situation that President Nixon inherited on his inauguration day in

1969

was truly frightening.

Any person who fully grasped the depth

of the problems that existed must have marveled at the intrepidity or the foolhardiness of any man who wished to assume the presidency at all under such circumstances. The Vietnam war was then at its worst, with the rates of dollar cost, of American casualties, and of civil protest at home against the war all at their peaks. The rate of the Federal budget decit was at a peacetime record which was then considered to be incredibly out of control. The rate of price ination was the highest since ination had risen to a rate of almost

8

1951

and rising. Money

percent per year, which was far

faster than the fastest rate that had previously been seen since

1946.

The

American social fabric was in an appalling state of strife, disunity, and ferment. For the more fearful among those who could see the gravity of the situation, it was possible to foresee that some sort of collapse must surely come within Mr.

Nixon's rst term, no matter what he might do.

This

collapse, of course, did not come within that time span, although it did

202

approach ever nearer. President Nixon's years divide into two distinct periods at approximately the middle of

1970.

The rst of these, lasting for about eighteen months,

was the rst scene of Mr. Nixon's second act, and the dierence between the two scenes was so extreme that the dividing line between them may well turn out to have been that momentous turning point of the entire inationary drama. During the rst scene, the government strove mightily to throw a harness on the dragon of ination by imposing various economic restraints of a rather stringent sort.

After a few months of oce for taking bearings,

the campaign went forward vigorously. It proceeded on two fronts, both quite conventional for such campaigns. The Federal Treasury reduced its expenditures and strove for a balanced budget, which it did approximately achieve for the scal year from July

1969

through June

time, the Federal Reserve System tightened money. clipping along at about

8

At the same

percent per year, the rate of money ination

began to drop sharply in May of amounted to only about

1970.

From having been

3.8

1969,

percent.

and by the following year it had In essence, the campaign was as

simple as that. The sequelae of this government strategy were perfectly predictable, and they occurred in a perfectly predictable sequence and time scale.

The

almost instantaneous rst result, as always, was that the stock market fell. Within two months after May

1969,

average stock prices had fallen by

percent, and within another year they were down by

31

14

percent. At the

same time, interest rates instantly began a steady rise to the unprecedented heights of the spring

1970 credit crunch.

These were the rst results. Much

more slowly, in fact not reaching the worst until late

1970 after the strategy

had already been abandoned, business began to turn sour, prots began to plummet, workers were laid o and unemployment rose, and recession came. The one result that did not follow was an end to the price ination. Prices were still climbing about as fast at the end of this scene as at the beginning. This circumstance led the government to believe that the strategy was failing and that the old rules did not work any longer. This inference was totally wrong. There was nothing intrinsically wrong with the government's "game plan," as it liked to call it. But the government expected far too much of this strategy, right though it was, and expected the desired results

203

35 President Nixon Begins far too quickly. The government's only mistake was to underestimate how deeply entrenched was its enemy. It had taken three full years of far tighter money to reach price equilibrium in success sooner in

1970.

The money expansion rate of

1948, and there was no reason to expect

3.8 percent per year during the tight money

was only half of what had preceded it, but it was certainly not non-ina tionary.

1966.

It was nothing like the zero money growth of

1948,

or

1957,

or

It was about as high as the ination rate which had started it all in

the rst four years of the ination under Presidents Kennedy and Johnson; it was as high as that which produced the boom and ination of

1956;

and

it was almost as high even as the deplored ination of the Korean War. It was no lower than the current rate of price ination, which meant that it was merely keeping pace and making no inroads at all on the Index of Latent Ination. This rate of money expansion would have ibeen good for a perpetual ination of at least

3

percent per year, accompanied perpetually

by the recession which was impending. That at least would have been bet ter than a perpetual ination of

6 or 7 percent,

accompanied eventually by

the same sort of recession, such as would have followed if the tight money had not been imposed. Though President Nixon's timid tight money was at least on the right track, the government's extreme budget cutting of

1969

was a mistake.

The scal solution of the balanced budget was greatly overplayed. When so much of the nation depends on government spending for its livelihood, budget-cutting merely cuts the props from under these people and leaves them unemployed, doing nothing to help ination. Avoiding that budget shock wave might have ameliorated the resulting recession and permitted the government's healthful tight money to continue for a longer time, pos sibly even for a long enough time. But it was not to be. By the summer of

1970,

the government had reached its Rubicon. The

next presidential election was then little more than two years away, and Mr.

Nixon knew well from his

1960

experience that economic restraint

must not be allowed to persist any closer to an election than that.

In

the event, the abandonment of economic restraint turned out to be almost perfectly timed to allow recovery just before the election. In addition to politics, there was the problem of solvency.

The Penn Central Railroad

had just collapsed, Lockheed Aircraft was on the brink of bankruptcy, and money was so tight and interest rates so high that a national wave of

204

nancial collapses seemed to be in the making along with the worsening unemployment and contracting business. So the government laid down its arms, burned its forts, deserted its po sitions, and ed. What this meant simply was that the government turned on the money ination and government decit spending again full blast, as full as ever. Commencing approximately with August

1970,

the govern

ment's: budget decit dived to new peacetime depths, and a remarkably steady new money ination rate of around

6.5

percent began and contin

ued throughout the next years. Those three percentage points of increased ination, a mere six billion dollars of new money a year, made all the dif ference in the world. Interest rates plunged, the stock market soared, and the nation was back on ination's high road to prosperity. The government's brief defense along the line where it had dug in at the beginning of the Nixon administration was forgotten, and no further eort was made to dig in along any line. To say that the government thus failed in its assignment, which is true enough, is not necessarily to say that this line of defense could have been held. Without other fundamental economic reorganizations, none of which was even being considered, tight money and depression very possibly could not have been tolerated long enough to have any eect on ination. In other words, the government's defense lines very possibly were going to be overrun anyway.

Be that as it May, the

government's relieved abandonment of the defense in the summer of

1970

is what marks the end of Act Two, Scene One, and perhaps that elusive turning point of the entire drama. For it was not at all certain that any further eort to stanch the ination by correct methods, even as resolute as this irresolute one, would ever be made in the future. There was no longer any practical possibility that ination at least as bad as then existed would ever be arrested, short of some kind of traumatic denouement.

205

35 President Nixon Begins

206

36 Act Two, Scene Two: Price

Controls and Other Follies

Scene Two of President Nixon's administration was the silly season of the ination.

Everything was the opposite of what it appeared to be.

The

nation appeared to be in better health economically, but it was worse. The government appeared to be trying to hold the line against ination, but it was actually fostering the ination at a prodigious rate. And the strangest and silliest of all the delusions that dominated the consciousness of that day was that ultimate folly of ination ghting, price controls.

This chapter

is basically about price controls, because price controls were all that the government had left after it abandoned all its real defenses. The factual course of the period was simple. After the government turned on its decits again, it kept them on. After it turned its money pumps back up to that

6.5

percent annual rate, it kept them there. The government

persuaded itself that that rate of money expansion was about right for "noninationary growth." Never mind that that was well above the rate of the worst ination after World War II and before

1967.

That was a nice

moderate rate of ination and the government would keep to it, which it did. The government's conduct was steady and it was unremitting, that much must be said for it. It did not vacillate any more. It followed a good straight course, and it moved along as constantly as it could. It was much like Napoleon's retreat from Moscow. The natural eects of this new combination of policies were as predictable as those of the old game plan had been. The stock market rose and interest rates fell. Later, after the usual long wait, business and employment turned up again, the recession went away, and prosperity appeared to return. By the end of

1972, when the presidential election came to pass and Mr.

Nixon

was re-elected, the nation was in a boom. A year later, however, this time without any reduction in the rate of money ination, the stock market had fallen again, interest rates had risen again to surpass even their previous

207

36 Price Controls peaks of

1970,

price ination was worse than ever, and recession seemed to

be impending again. Strangely enough, the rate of price ination, which had not improved during the stringency of

1969

and

1970,

also did not improve when it was

ended. The government should not have expected the price ination to do anything but become worse once the government renewed its money ina tion, but it did seem to expect otherwise. The government professed great perplexity that the price ination was still cruising along at somewhere above

4

percent, gathering its breath for a new upsurge with the boom

to come, in August of

1971

after a year of renewed money growth. So the

government roused itself to the most dramatic kind of grandstand play that it could envision, and that was President Nixon's famous announcement of Phase I of price controls on August

15, 1971.

Another international money crisis was then in progress. The constant outow of cheap dollars from the United States had inundated the Euro peans again, and since May they had more or less discontinued supporting the old exchange rates but were resisting an upward revaluation of their cur rencies against the dollar. Most of the aspects of Mr. Nixon's August plan were directed to the international money situation. Among other things, he announced immediate detachment of the dollar's value from gold, a sort of oating of the dollar; he announced an import surcharge of

10

percent

to force other nations to raise the exchange value of their currencies; to en liven the sluggish domestic economy, he announced removal of excise taxes on automobiles, as if the proliferation of automobile economics was not already overblown enough; and above all he announced a ninety-day freeze of wages and prices as Phase I of his new commitment to wage and price controls. The commitment to price controls is important. Nothing much else about the August edicts was important.

The continuing international money

crisis was temporarily resolved later that year by the international agree ment known as the "Smithsonian agreement," which re-established xed exchange rates for the time being and generally devalued the dollar. The other eects of the August edicts were largely miscellaneous.

The com

mitment to price controls, however, was commitment to a new rst line of defense against ination that was totally incapable of doing any good and quite capable of doing active harm. Price controls were the darling of liberals of every kind, and especially

208

the liberal wing of economists who were the same wing that had created the ination in the rst place. If ever there was an apt example of King Canute commanding the tides to be still, and mobilizing his minions to og the waves when they would not, it is price controls. Price controls appeal wonderfully to the King Canute complex among liberals. For years, and more particularly since the despised President Nixon had come to power, they had been preaching price controls to hold down the natural forces that they themselves had insisted be unleashed. In the end, President Nixon, who was not a man to go down ghting in an outnumbered cause merely because he was right, switched to the enemy camp and thereby got com mand of it. It was very clever. Leonidas the Spartan should have mastered that maneuver. When the people screamed for controls, President Nixon gave them controls. When they screamed against the resulting shortages, President Nixon removed controls. It was a Greek farce. And since nothing else was being done, the farce must continue. Price controls have as long and honored a history as ination. In four thousand years of ination, price controls have a perfect record of four thousand years of total failure to control ination. Two of the best examples were World War II in the United States and the German ination during and after World War I, when price controls were termed by Lord Keynes "not the least part of the evils." Always and everywhere, price controls have failed to escape any part of an ination in the long run and have usually helped considerably to make ination worse. It is not possible to mount a really catastrophic ination without the able assistance of a rst-class set of price controls, as the United States of

1946

and Germany of

1922

well

learned. It would be idle to assert that price controls do not control; prices. Ob viously they do. Controlled prices are lower than they would be without controls.

Many critics who are philosophically opposed to price controls

do their own cause a dis-service by claiming that controls are ineective on prices, as they did during the relatively successful Phase II of President Nixon's program. If that were true, price controls would be doing no harm either.

Price controls do hold prices down.

Their eectiveness in World

War II America or in inationary Germany cannot be disputed. But con trolling a price below its natural level or its natural rate of increase does not destroy one single percentage point of ination. Like matter, ination is indestructible. Price controls merely postpone ination, cover it up, hide it

209

36 Price Controls away, and store it. Price controls merely transfer the inationary potential manufactured by the government to the reservoir of latent ination instead of being realized on a pay-as-we-go basis. That is all that price controls can ever do. If this were the worst that price controls did, they would do no active harm. If the government's policies were no worse under price controls than they would be without price controls, postponed ination would be no worse in total than immediate ination. In real life, this seldom happens. Ination deferred is ination forgot, and not merely forgot but joyfully ignored.

The only ination a government can understand is ination it

can see, and if it can see none because of price controls it feels free to act as if there were none.

This is why a rst-class set of eective price

controls is indispensable to a rst-class inationary collapse. Without the self-deception of price controls, the government is forced by the rising prices to nd some less facile way of nancing than unlimited money ination. The interesting example of the Korean War price controls bears mention. This episode was sometimes oered as a case of successful price control without retribution, and contrasted with the case of World War II price controls. After the removal of World War II controls, latent ination ex ploded, but after the removal of Korean War controls, nothing happened. This shows merely that the Korean War controls were unnecessary and were accomplishing nothing, although they also were doing no harm but to waste the time of everyone. There was no latent ination at the time of the Korean War. The government over-reacted with its controls to an ination that was not there. United States of

That episode should have oered no comfort to the

1973, however, because the situation then was increasingly

like World War II and not like the Korean War. The full avor of the foolishness that prevailed in the United States after the commitment to price controls in

1971 it is dicult to convey.

This was

what made Scene Two in Mr. Nixon's act the silly season of the ination. Having abandoned the last serious eorts at defense, the nation gave itself up to sound and fury signifying nothing. In place of policy, there was only obscuration. The government laid down smoke: screens to conceal the ab sence of any defensive forces. Day in and day out, newspapers were lled with column upon column and page upon page of doings and dissertations of the Price-Commission, the Wage Board, the Cost of Living Council, the president, the unions, most of the bureaucrats, all of the politicians, and.

210

every conceivable kind of self-appointed expert on what the price controls were doing, what they were going to do, what they should do, whether they were succeeding or failing, and so forth. Phase followed phase of price controls. At every turn the ination was worse. Now there were consumer boycotts and protests, followed by counter-protests and boycotts by pro ducers, and the government chiming in like King Canute with price freezes and defrostings and new kinds of controls.

It was all of no consequence

whatever. Inability to see beneath supercialities is the stamp of every severe in ation, and never was this more conspicuous than by

1973.

If there was

a sudden areup of rising prices like meat and food, the nation could be come alarmed and incensed and demand legislation about it. If there was a temporary abatement of rising prices, as during the controls of

1972,

the

nation could believe that there was nothing wrong any longer. If the in ation was supercially less bad and the prosperity supercially better in

1972

than previously, the nation was able to feel that its economic health

was improved when actually it was worse than ever.

The hopefulness of

the nation, its government, and its people, peeping around each new corner in hope of nding the ination gone away and health restored, was both touching and pathetic. Neither of those boons was ever going to be found on the path it was then taking. The incredible Watergate aair aicted the nation almost more than anything else in its travail. Watergate was an absurd little political gae committed by some of the more foolish of Mr. Nixon's political troops in the re-election campaign.

The forces of the liberal opposition, who had

been soundly thrashed in the election, immediately set about to undo both the election and the president with the Watergate incident. Only in Amer ica could political trials have the President of the nation as the quarry, and all the mechanisms of law in the nation be bent on the lynching of their own leader. The most important segments of the nation's press, which had uniformly indoctrinated the public with misinformation and misjudgment of the ination, now diverted all useful attention away from it to the Wa tergate aair. All the nation attended the circus while Rome burned down at home. The Watergate hounds baying after the president bore a similar ity to the downfall of Matthias Erzberger in his

1920

libel trial with Karl

Helerich, and the economic consequences might be just as grave. The simple fact was that the nation by the beginning of

1973

had still

211

36 Price Controls paid hardly more than half the cost, in price ination, of the fun and games it had been buying for itself over the ten years since

1962.

Such prosperity

as the nation still enjoyed was still false and still totally dependent on the continuing and accelerating ination. The price ination since

1969

when

Mr. Nixon entered, bad as it was, only about equaled the money ination in the same time.

The price of the six years under Presidents Kennedy

and Johnson that preceded Mr. Nixon was still due and payable, and the implacable creditor of ination was pressing. money ination in

1964

and especially

ination that was raging in

1973.

1973

1965

The failure to rein in the

was far more important to the

than anything that was being done in

It is possible that the die for all the remainder of the ination had

been unalterably cast by the close of

1965.

The dangerous part of any ination is the part that cannot yet be seen. The ination that can be seen is past doing anymore harm.

In

1973,

as

at any other point in the American ination, there was no power under the sun that could excuse the nation from seeing its prices continue rising ultimately to the equilibrium that past money ination had already xed. If the Index of Latent Ination had been correctly estimated, that would mean in

1973

that prices must rise by the additional

22

percent of that

index even if the money ination should stop the next day. Moreover, the money ination was not about to stop the next day. The money ination was still rollicking along at the same old steady

6.5

percent a year, which,

according to all the evidence of the preceding twenty-ve years, meant that the price ination too must rollick along at a minimum rate of at least percent per year forever, on top of the

6

22 percent one-time head of pressure

that had already been built up. The nation could not bear to let the money ination diminish. As Karl Helerich used to say in Germany, that "would have brought about a collapse of wages and prices, probably accompanied by crises and catastrophes," but no one seemed to notice that the nation must face up to those very crises and catastrophes someday. everything else, the nation even at

6.5

On top of

percent per year ination had the

look of entering into the kind of recession and inadequate prosperity that in the old days were only found in the company of zero ination.

That

might mean the government would have to turn up the money pumps another notch. The situation in

1973

was not good. It had seldom been

worse. Condence was unfounded. Complacency was ill-informed. Hope was misplaced.

212

If the prospect that confronted President Nixon at his

inauguration in

1969

was frightening, that which confronted him in

1973

was fundamentally more so. Any man who grounded his course of conduct on a belief that stability and health were not far away simply did not understand.

213

36 Price Controls

214

37 The Way Out One of the few philanthropisms of ination is this: technically, it is a matter of the sheerest child's play to stop an ination, any ination.

At least

that is true if the underlying economic system is in passably good working order, as those of both Germany and the United States were. Ination can be brought to a halt at any stage, early or late, before collapse or after collapse. It is even possible to halt an ination overnight, as was done in the German ination. In some ways it is easier to do after a collapse, when all the wreckage has been obliterated, and in other ways it is easier before a collapse, when the system is still working well. But it is easy at either time, and the steps necessary are essentially the same at either time. All that is demanded is that the nation nally pay up the perfectly payable price of its past greed. No voluntary cooperation by the people is necessary, the government can accomplish it without anyone's help. A nation succumbing to ination is like a man drowning within arm's reach of a shore he does not see. Make no mistake about this further fact: it is not a matter of child's play, in fact it is not possible, to stop an ination at any time without paying the price. The price of past misdeeds is always there, is nite in amount, is usually greater than is thought, invariably rises still higher the more it is evaded, is ineradicable, will not go away, and in the end will be paid. There are only three basic requirements for bringing any ination to a halt. They are, rst, that prices must rise; second, that money must stop rising; and third, that the money wealth must be devalued to tolerable levels. No more is required, but no less will do either. The rst of these requirements is that prices must rise. The nal end of an ination is of course that prices stop rising, but that can only happen after they have risen enough.

The essence of an inationary situation is

that equilibrium prices are higher than current prices are.

When prices

are allowed or encouraged to rise to their equilibrium, and not before, they will stop rising of their own accord. If the Index of Latent Ination

215

37 The Way Out accurately estimates the distance from current prices to equilibrium prices, then ination will end when prices rise further by the amount of the index. In the United States at the beginning of about

22

1973,

that estimated amount was

percent. Eorts to hold prices below their equilibrium by price

controls and the like, which are common to all inations, are futile. The only way to purge an ination is not to control it but exactly the opposite, to get it over with. Purging an ination by letting prices rise is of course very painful. As the pains grow more acute, there is a natural doubt that the rising prices will ever stop, as expressed by President Truman's desperate special message to Congress in

1947.

The answer is to keep cairn, salve the pain, be condent,

and wait. Ination will stop when it is ready to stop. Purging the ination may proceed either quickly or slowly, depending on how much latent ination there is and how rapidly the prices rise. If the government really wished to use its price control powers eectively to bring ination to an end, it would use them not to hold prices down but to force them up. For example, if the United States used its price controls to compel every seller to raise his prices overnight to the estimated equilibrium level, which by the end of

1962

prices (a rise of

30

1973

would probably be about

percent for the full year

1973),

168

percent of

and at the same

time to raise the wages he paid by the same amount as his prices, the latent ination would be quickly eliminated. Prices and wages could then be released from controls to act according to market forces, and they would rise no more if the latent ination had been accurately estimated.

That

is the overnight ending of an ination. It is like ghting forest res with backres.

The ground we burn intentionally is going to be burned over

anyway, and if we burn it ourselves we can prevent the re from going beyond it. The second requirement of stopping an ination is that the quantity of money stop rising.

Raising prices to eliminate inationary potential

works only as permanently as no more inationary potential is added by money growth. This means that the increasing quantity of money must stop completely. Zero money growth is requisite. Every central bank knows how to stop the growth of money if it wishes, and if it does the ination too will stop as soon as latent ination has eliminated itself through rising prices. The reduction of money growth to zero may be as abrupt or as gradual as one likes. As long as the rate of money expansion is constantly lower

216

than the rate of price ination by at least some amount, the inationary potential is eliminating itself and the ination will someday stop. The more gradually it happens, the longer it will take, and the pain will be less acute but more prolonged. The third requirement of stopping an ination is a more subtle one. Prices must rise enough to devalue the nation's money wealth to a level of real burden that its debtors can bear. Remember that the money wealth was the mother lode of the ination. Ination's principal function was to mine this lode, using the proceeds to buy prosperity and at the same time lightening the load on debtors. Debtors can only tolerate so much debt if it is real value, and ination has the paradoxical tendency to cause debt to grow far out of proportion to real wealth.

If ination is to be nally

abandoned, it must remove one last, huge chunk from the value of the money debt before departing.

This means, in its simplest signication,

that the assured further price increases represented by the latent ination (to a level of

168

percent of

1962

prices at the close of

1973,

according

to the estimated Index of Latent Ination) might very well not be enough price increases to lighten the debt load suciently. A further large infusion of money ination might be necessary before bringing ination to a stop. The nice question is how much is enough. of

1973

The government at the end

might, for example, have put out in a single day perhaps

100

billion new dollars before proceeding to extinguish the ination by raising

37 percent, the 168 percent, and

prices. That would have raised the money supply by about equilibrium price level to

230

percent of

1962 instead of 1973 to 77 percent instead of

the necessary total price increase for the year only

30 percent.

That would certainly devalue the debt enough. Somewhere

between that and the actual latent ination that was probably the right amount of price rise to devalue the debt. Balancing the survival of debtors against the injustice to creditors was a matter of delicate judgment. The part played by this one last burst of ination is vital. was an example.

Germany

The astute German managers of the Rentenmark plan

shut o the further growth of money only after "an immense access of ination," far larger than anything that had gone before.

The Germans

had to leap ahead of the astronomically rising price ination with a still more astronomical amount of money ination, and then instantly turn about and face down the prices and say "Halt!" It required great prowess, and they made it work. No one should underestimate the necessity of this

217

37 The Way Out feat. The fantastic amount of paper wealth accumulating right up to the last day of an ination could not be allowed to exist as real value in the new stability without ruining the debtors. The reasonable expectations of the creditors that their credits would be good had to be disappointed, and the unreasonable expectations of the debtors that their debts would be written o had to be realized. It was not just, it was just necessary. The reduction of debt to a tolerable level will take care of itself in one way or another, if not by a nal burst of ination then by wholesale bankrupt cies. Bankruptcies are wasteful and inecient and do not really help the creditors, when compared with the ease and eciency of writing down the entire debt structure by a single stroke of the government on a single day. If anyone should protest the injustice to creditors of this stroke, he may be answered rst that it is necessary, second that the government had been doing the same for decades, third that it is in the creditors' interest too that the nation regain health, fourth that the loss is smaller than the possi bly complete loss creditors may expect if the ination proceeds, and nally that the devalued wealth was probably not well earned real wealth anyway but only easy wealth owed mainly to the inationary boom. These three steps are all of the technical prerequisites for ending an in ation. Ending the ination in the United States presented a fourth major problem, however, and that was the problem of providing sucient pros perity for the people after the inationary drugs were removed.

Strictly

speaking, providing for prosperity was not a true prerequisite to ending the ination. Any moderately competent American economist knew how to stop the ination by stopping the money, if that was all that was asked. The nation would soon be economically prostrate if no more than that was done, but, strictly speaking, that would not alter the fact that the ina tion was over.

Even Karl Helerich knew all this.

It was those "crises

and catastrophes" that would ensue that led him like everyone else to be lieve that ination was less bad than the alternative. The same prosperity that lured the nation into ination in the rst place also deterred it from leaving. Providing for prosperity must therefore be taken as a fourth neces sity for leaving ination for all practical purposes, forgetting about strictly speaking. Notice that the problem of prosperity was peculiar to the American ina tion and not characteristic of all inations. It was what made the American ination more dicult and more dangerous than any previous ination of

218

history. In Germany of

1924,

by contrast, there was no enduring problem

of prosperity after the ination had ended. There was an adjustment in the form of depression and unemployment for less than a year, and after that employment and prosperity became quite satisfactory through the normal forces of economics and without help from the government. States in

1973

The United

was dierent. Americans had been accustoming themselves

to the unreal degree of inated prosperity not for a year or two as the Germans did, but for literally a generation.

Millions of Americans had

never known any kind of prosperity but unreal prosperity.

Readjusting

themselves to real life was not going to be as easy for them as it had been for Germans.

Although the American ination was less severe than the

German, its much longer duration made its psychological scars likely to be even worse. Still more importantly, the United States was much more mature economically than it or any other nation had ever been. It could not possibly employ all its available citizens and supply them with ade quate earning power without either using progressively worse ination or drastically reorganizing its economic structure. In short, the United States was so rich that it could not be suciently prosperous in its existing orga nization without ination. No other nation, inationary or not, had ever faced this problem. Technically, this new problem of prosperity was no more dicult of so lution than the old problem of ination itself. Practically, it was far more dicult. Eliminating ination could be done by the government with no co operation from the people, but regaining prosperity could not. Prosperity required a far more extensive program of radical surgery on the economy. It required intelligent legislation, where merely halting ination required no legislation.

It also required legislative treading on some part of the

jealously guarded preserves of practically every important private interest group in the nation, and that is seldom successfully done by democratic legislation. The technical program for severing prosperity from ination, allowing the ination alone to die, has been outlined earlier in this book. At the barest minimum, there must be massive new capital taxes to take the place of the ination tax, and there must be some eective method of distributing the proceeds of the capital taxes to the people for consumption. The abundance of the new prosperity would, I think, be in the direct proportion that the nation adopted the whole program and not merely the minimum program,

219

37 The Way Out the whole program being the adoption of net worth, inheritance, and capital gains taxes; adoption of uniform income taxes and elimination of low rates and exemptions; elimination of double corporate taxes; establishment of a universal national dividend and abolition of all other distribution systems; removal of all government legal props under artically high wage rates; and introduction of a free market in labor. The minimum program would produce a less abundant prosperity, but even the minimum program would at least allow the nation to navigate safely past the rocks of depression. The kind of prosperity that could still exist if ination were renounced might well be a dierent kind of prosperity. Many people might not like it so well. It would be above all a real-life kind of prosperity, and that might well be humdrum in comparison with the unreal prosperity of the ination, like a return to sobriety after a trip out on hallucinatory drugs. dollar would be hard earned and therefore carefully spent. be less luxury.

The stock market would be becalmed.

Every

There might

Wage increases

would be dicult or impossible to get, and wages themselves might be unspectacular.

Employment would be useful and therefore humbler, less

glamorous, and perhaps less fun. The prosperity might not seem like the promised land. It might be a bit boring. On the other hand, every man could have a job. Purchasing power would be good, not lavish perhaps but still good. The most useful citizens would be the best rewarded. Poverty should decline. Real well-being should begin to rise again. Leisure might increase. And there would be no ination. America could nd a stable and mature cruising speed. It might not be too bad either. The problem of prosperity was independent of ination in more ways than one. Merely continuing the ination was no assurance of continuing the prosperity. Insucient prosperity was going to emerge in the United States again whether it renounced ination or not. That was because of the Law of the Exponential Ination, which made it necessary to compound the ination continuously in order to keep the prosperous eects, but com pounding to innity was not possible.

The choice between ination or

a renunciation of ination was not a choice between an easy and familiar route to prosperity or a more dicult route to prosperity. Not at all. With out radical transformation, the nation would soon have both ination and depression. It was a choice between prosperity or no prosperity, between living poorly or living well, and between living in a declining state or in an improving state.

220

Notwithstanding all that, in

1973

the choice between ination and a

renunciation of ination appeared to be a choice between easy times im mediately or hard times immediately. Ination was still potent enough to postpone the hard times a while longer into the future. It was actually a matter of hard times immediately or harder times later, but that was not fully apparent, and in any case hard times while they stay in the future are not very painful. For that reason, virtually no one in the United States really wanted to end the ination. Despite all the verbal indignation that was heaped on ination in all its stages by the people, their leaders, their spokesmen, and their press, it was all purely verbal indignation Almost literally no one really wanted to end the ination with all that that would entail. It would repay anyone handsomely to note that well.

221

37 The Way Out

222

38 The Way Ahead The way that actually lay ahead of the United States in

1973

seemed not

very likely to be similar to the way out of the ination. This chapter takes a look at all the preliminary drafts by the master playwright for the third act of the American ination. As with any good drama crafted with validity and truth, there were only a few basic variations which would not exceed the bounds of reality.

Each variation owed with inevitability from the

conduct of the players in the drama. Since this chapter looks to what was the future in

1973, the reader should

be charitable toward whatever errors of foresight may appear. From the rst day after these words were written, the reader possesses better infor mation about the unfolding ination than the author had.

These words

might even be read at a time when the nal conclusion of the American ination is known, and in that case the reader's privilege of comparing the prognosis with the autopsy is an enviable one. Which course the third act of the American ination might take was a purely political question and not an economic one. There were no economic problems in the American ination, only political problems. If the govern ment did A, then X would follow economically, and if the government did B, then Y would follow economically; but the choice between doing A and doing B was a political question. There were really only three possible basic drafts for the third act of the ination. The rst of these was one called "Tight Money." This was the one in which the play would end with the band of hardy strugglers nding their way safely out of the deep and perilous forest, much battered and wounded but safe at last. This was the draft ending which was elaborated at length in the preceding chapter, entitled "The Way Out," and it was the one course of action which could hope to reduce or eliminate the American ination without deepening harm. In the absence of this course of action, the American ination would most certainly never be reduced or eliminated without rst writing o the dollar and the dollar wealth.

223

38 The Way Ahead Tight money had been tried by the government intermittently over the course of the ination, abortively in every case since

1962, and it was possi

ble that it might be tried one or more times, probably abortively, again. If the major structural changes which were described in the preceding chap ter were not made, however, and it seemed exceedingly unlikely that they would be made for the reasons given there, then the economic depression and unemployment which would follow from tight money made it practi cally certain that the tight money would never be tight enough or persist long enough to reduce the ination signicantly. In theory, even in the ag gravated circumstances of

1973,

a naked policy of tight money alone with

no great structural changes could still do the job, ending the ination and leaving the economic system alive and breathing, but just barely.

The

accompanying depression would certainly be deeper than any that had oc curred since World War II, and it was not a strong possibility that any political government would allow itself, or be allowed, to let that happen. The second basic scenario for the last act of the ination was one called "Stabilized Ination." According to this draft, the drama would have no clear-cut ending in the classic sense. It was the not-with-a-bang-but-a-whim per ending. This complex of conditions would come to pass if the govern ment despaired of ever making any signicant reduction of the ination and simply surrendered to it. It would adhere to a constant and moderate rate of money ination such as the

1973.

6.5

percent per year which was prevailing in

By so doing, the government would accept the prevailing ination

de facto and simply resolve not to cause it to become any worse, and for ever after the ination would simply go on at the same steady rate. The curtain would fall whenever everyone was willing to give up on victory and persuade himself that the defeat was really a tolerably honorable draw. Stabilized ination has some good points in the real world. Its principal good point is that it is achievable in the real world. The body in motion is allowed to stay in motion, at the same speed and in the same direction. The dismaying consequences of trying to escape from an ination need never be faced. A truly stabilized ination, in which prices are truly free to rise at their own speed, is fully as stable as a condition of steady prices, and there is no necessary tendency to degenerate into a worse ination. On the other hand, a truly stabilized ination in the United States would not be by any means the long-sought condition of prosperity. If prices were genuinely free to rise at their own speed, and they adjusted themselves to a

224

steady

6.5

percent money ination by rising steadily at perhaps

6

percent

per year themselves, the economic condition of the nation would still be a condition of insucient prosperity.

It would resemble in all respects

the condition traditionally known as Tight Money. A steady money ination, in the presence of a steady

6.5

percent

6 percent price ination, would

be exactly as tight a money policy as zero money growth in the presence of stable prices. Prevailing interest rates would have to be of the order of percent to

15

10

percent per year. The money ination, having no marginal

speed advantage over price ination, would yield no benecial stimulation, and the state of unemployment and insucient prosperity would therefore be exactly as bad as before the ination ever started. If prices were not permitted to rise freely at their own speed, then the ination would not be a stabilized ination.

If only the money ination

proceeded at that steady but moderate pace, and prices were articially restrained to a slower pace, the danger represented by the large latent in ation would increase. Since the marginal speed advantage of the money ination over the price ination was being maintained, this course of ac tion might temporarily continue to have some benecial eects. Prosperity might be a little better, interest rates a little less high, and unemployment not so bad as in a truly stabilized ination. But the relative safety of the stabilized ination would be sacriced, and unlike the stabilized ination there would still be every danger that the situation might degenerate into a worse ination. By

1973, the stabilized ination was about as conservative a course as the

most conservative political government could be expected to follow for any extended period of time in the United States. Undertaking the terrifying journey out of the ination seemed out of the question.

The spirit of

the times was not to seek dicult victories, but to settle for moderate defeats. A stabilized rate of money ination was the course that President Nixon's government seemed to be following throughout the three years from

1970

through

1973

percent per year.

with a remarkably constant money growth of about

6.5

There was frequent talk, alternately, of tight money

conditions and easy money conditions being maintained by the Federal Reserve System, but in fact there were neither.

There were unusually

steady money conditions. Arthur Burns, chairman of the Federal Reserve Board, was an adherent of the Friedmanite school of thought that any kind of monetary trend, tight or easy, if it was a steady trend, was better than

225

38 The Way Ahead the constant alternation of tight and easy money that had bedeviled the nation for decades. The Federal Reserve seemed to be testing this thesis, and it was a most interesting experiment. Though the prerequisite of steady money growth was being satised, however, the relative safety of a truly stabilized ination was still far from secured, mainly because prices were not yet being allowed to rise at their own speed.

As a result, interest rates were not nearly high enough and

insucient prosperity was not nearly bad enough for a stabilized ination. As

1973 wore on, however, interest rates were rising past their old peaks to

new historic highs, prices were being forced free to rise by shortages and market distortions, the stock market was deated, and signs of approaching recession were appearing. All this came to pass without the least reduction of money expansion such as had always been the cause of these symptoms in the past. Stabilized ination had not arrived, but it was coming. The acid test of the conservative government's mettle would come when the full rigors of the stabilized ination began to be felt, with faltering business, worsening unemployment, insucient prosperity, unheard-of interest rates, and cantering price ination, all with the same old steady money ination of

6.5 percent a year.

The epic question then would be whether the govern

ment could still stick with its steady rate of money growth or must instead take the next quantum leap upward to money ination of perhaps

10

per

cent a year or more in order to abate the depression. That latter course would be the way to the third and last of the draft scenarios for ination's nal act. This last draft of the nale can be called the Geometric Ination. It is another name for the big bang, or German, ending. It has a distinct avor of the Gotterdammerung about it, and one must infer a certain Wagnerian inuence on our master playwright if he should elect this ending for the drama. Each new step in a geometric ination would occur when the gov ernment, dissatised with the stagnation that accompanies stabilized ina tion, lifted the rate of money ination by a fresh quantum leap. The faster rate of money growth might temporarily restore the desired conditions of low interest rates, full employment, vigorous growth, and prosperity, but only until the price ination was again restabilized at the new higher rate, accompanied again by all the old symptoms of unemployment and insu cient prosperity. The government can go through this as many times as the people will tolerate, but at every new level the choice is the same: either

226

an entrenched and permanent ination, with recurrent insucient prosper ity but without increasing danger, or a newly increased money ination with temporarily improved prosperity, increased danger, and a guaranteed increase in price ination in the future. This is the practical working of the Law of the Exponential Ination. It is not a true economic law because the government always has the theoretical ability to draw a line and say, "No farther!" But the practical compulsions upon the government to take each new step of the geometric ination are very great. And the only possible ending of the geometric ination, if it is repeated again and again until it will not work any longer, is the German ending. These three  Tight Money, Stabilized Ination, and Geometric Ina tion  were the only permissible drafts for the last act of ination that did not violate reality. Of course, it was possible to conjure up other fanciful endings. It was possible to dream of a Saint George riding out of the mists with his magic sword to slay the dragon and leave everyone to live happily and prosperously ever after. This was just the sort of ending that people in the grip of an ination do customarily trust in. It was just the ending which most Americans, people and government alike, were in fact trusting in. But it was totally fanciful. It belonged to the world of fairy tales and of real life. Only certain kinds of endings for the American ination were admissible in the real world, and the Sain George ending was not among them. One other kind of denouement for the American inatio is worth men tioning, not because it was likely to happen because it was not. This was the Great Depression of

1929-1933,

replayed. This was deation. In this

draft, the govern ment would tighten money so hard that business and the securi ties markets would collapse, unemployment would soar, people would turn inward, prices would fall, and the value money wealth would actually increase. Not long before p cisely this sequence was set in train by the Federal Reservi in

1928,

John Maynard Keynes himself was foreseeing

thi probability of ination for the United States.

Humility mus rule be

fore so distinguished a misjudgment, but still deation was not practically

1973. Ination and deatio had been equally available to the 1928, and was pure gamble for Lord Keynes to predict one than the other. They were not equally available in 1973. The bur

possible in

government in rather

den of the total debt would have become doubly intolerable if the value of money had not merely stopped falling but actually risen, as in a deation,

227

38 The Way Ahead and the government knew very well how to prevent that by inating the money. The government's own enormous debt, a factor which signicantly

1928,

would force the government to issue money sim

ply to service the debt.

The deationary ending was as fanciful as the

was not present in

Saint George ending, possibly more so. It is said that generals are forever preparing themselves to ght the last previous war, and the same was true of Americans in

1973

who were still arming themselves to ght the last

previous depression. As between the two most probable courses ahead for the United States in

1973,

the stabilized ination and the geometric ination, which was more

probable remained exceedingly unclear.

Three more years of President

Nixon's administration remained, and his previous administration had re sisted worsening the ination with reasonable rmness although it had also done nothing whatever to improve it. On the other hand, his administra tion had also been willing to turn ination on again forcefully in

1970

in

the face of unpleasant economic conditions. In the likely event that similar conditions returned again with the ination undiminished, his administra tion might be willing to turn the ination on still harder by taking the next leap upward in the geometric ination. It was uncertain. If the third act of the ination had not been played out before the elections of

1976,

which were to be the celebrated bicentennial of the republic, the choice of the person who would become president then might very well be decisive of the republic's fate. The specter that waits in the wings of any ination, including the Amer ican, is the general exodus of the people from the currency when they lose faith in it at last. When this specter steps in from the wings, the govern ment's games are over and the nal curtain is not far away.

There had

been no sign of this specter in the American ination at any time through

1973.

The stolid willingness of Americans to absorb inated dollar wealth

had been and continued to be enormous.

The level of understanding of

the ination was of course very low at all times, and this had its good side in keeping the specter away. In

1973,

Americans were actually deepening

their commitment to money wealth by a tendency to invest more heavily in bonds and debt obligations as a result of the severe stock market losses of recent years. Americans had been standing docilely still for the eecing for years, and there was no telling how long they would stand for being skinned as well before they would bolt.

228

The American position in

1973

was moderately grave. The Index of La

tent Ination at the beginning of the year was over

22

percent and could

not fail to become worse unless the current rate of price ination was con sistently worse than the money ination. This was smaller than the latent inations in the United States at the close of World War II, or in Germany near the close of its boom in

1921,

but still grievous in view of the nation's

inability to cope with it. As Shakespeare's dying Mercutio said of his own mortal sword wound, ...

'tis not so deep as a well nor so wide as a church door,

but 'tis enough, 'twill serve . . . Near the end of

1973,

yet another economic crisis menaced the grossly

overextended nation. As a result of another brief war between Israel and its Arab neighbors, Arab oil producers began to shut o the supply of oil to Western nations, especially the United States. Almost instantly, American industrial activity across its whole range began to contract. Crises like this one often passed over as quickly as they came, and moreover the crisis was technically no more insuperable than the ination itself; but if the crisis did not pass, and if the government surmounted it no better than it did the ination, the crisis could easily supply the nal spark to the explosion of the ination. Having stretched the dollar to its ultimate limit just to stay aoat in the best of times, the government had absolutely nothing in reserve for even slightly less good times. Any serious economic reverse such as a crop failure would operate in the same way. As shortages spread, the supply of values decreased, businesses closed, workers were laid o, and tax revenues fell, the government would be forced to inate more than ever before in order to nance itself and answer the universal cries for help. Much the same role was played to the German ination by the French invasion of the Ruhr in January

1923,

followed by German passive resistance that shut

down much of the German industrial machine. Every ination, from the rst day that its proprietor government begins it, contains the seeds of the German ending. Each ination also contains inbred compulsions upon the government to continue nursing these seeds to full growth. It is a commonplace of history that the nation which cannot learn from the past condemns itself to repeat it. To act in the condent belief that there was no valid comparison between the awesome German ination and the still moderate American ination was to out that com

229

38 The Way Ahead monplace.

If.

the United States could learn quickly from the German

example, it could escape its own ination and leave the two in nal retro spect quite dissimilar. If it could not learn the lessons in time, the deeper similarities between the two inations were bound to emerge more clearly as time passed. President Nixon, a conservative and businesslike president, might nd himself playing the American role of the conservative and busi nesslike German Chancellor Wilhelm Cuno, who for the worst part of the German agony totally failed to arrest an ination he never made.

230

39 Democratics "Democratics" is a name that might be applied to the functioning of pol itics in a democratic system. The United States in its great ination was still one of the most highly democratic systems the world had ever seen. If political problems and not economic problems were the root of the Amer ican ination, and if the American system failed to solve those problems, then the democratics of the American system would be the cause of the failure. Democracy's historical record of performance in inations was never good.

Numerous were the democracies which could not arrest inations

without undergoing either collapse of the currency or political convulsion or both. Few were the democracies which did not fail in this way once big inations were established.

Ination is the plague of weak governments,

and democratic government is in essence weak government. The American democracy had become fully as weak as the supremely democratic Weimar republic that failed in the German ination. Democracy's weakness is inability to act. No one, not the most ardent democrat, would maintain that ability to act is one of democracy's strong points. That is the very antithesis of democracy. Given the action to be taken, it is the autocracy which can take the action quickly, eciently, and forcefully, and the democracy which cannot. This is not to advocate autocracy, which has many well-known failings of its own. It is merely to say that democracy is not in one of its elds of strength, but of weakness, when it needs to take immediate, drastic, intelligent, and singleminded action in a matter as perplexing, as fraught with factional conict, and as vexed with dierence of opinion as ination. Rising against military attack comes easily to democracy; rising against ination does not. Democracy's very inability to act is one of its sturdiest virtues in other circumstances. The true genius of democracy is its ability to smother with inaction the wild notions and mad causes that send bodies of its citizens tilting in all directions in every era, and to smother them in so impersonal a

231

39 Democratics way that the smothered citizen cannot identify anyone who has frustrated him except "the system." When inaction is the best action, as it is most of the time, democracy performs well. Impotence before a crisis like ination is the price democracy pays. Nothing inherent in the nature of democracy compels it to be impotent before a need for action. If all the citizen-members of a democracy were en dowed with self-reliance, intelligence, and a measure of self-denial sucient to reach agreement on the sacrices aecting them all which were necessary to liquidate an ination, their democracy could take the necessary action quite as readily as any autocracy. This ideal democracy of sturdy yeomen is as unknown to history as the ideal autocracy of the philosopher-king, but there are degrees of impotence and degrees of sturdy yeomanry. Some democracies would do better than others, and the American democracy itself would have done better in other times than in

1973.

The American

democracy had never in its history seemed more barren of statesmanlike im pulse, more wholly dedicated to narrow self-interest, and therefore weaker, than it had become by

1973.

Two tendencies, both conspicuous in the American situation, are po tentially fatal maladies to a democracy.

Both of them are paradoxical,

inasmuch as both are hyper-developments of two of the noblest privileges of democracy. One is equality, and the other is individual rights. Democ racy is supposed to promote equality among men, and it does, but extreme egalitarianism is perversely the destroyer of democracy. Democracy is also supposed to promote the individual rights of citizens, and it does, but mil itancy in the prosecution of individual rights is the mortal enemy of the existence of rights.

Between them, these two tendencies account for the

extreme weakness of the most extreme democracies. The problem of egalitarianism is easily stated. A democracy can hope to function best when the members of its government are more capable men than the average of its citizens. The people are the parents of their govern ment, and not the other way round. Like parents occasionally begetting children more gifted than the parents, a democratic citizenry can sometimes elect rulers who are better men than the citizens. In a democracy, it must happen. It happens when voters have a deferential willingness to elect men they instinctively sense to be wiser than they, and then to leave the gov ernment to them. Even the miserable Weimar republic had many superior individual men among its Reichstag members. The United States itself had

232

many superior individual men among its past Congresses, and they tended to have inuence disproportionately greater than their numbers. No more. The spirit of the time in

1973

was extremely egalitarian. Deference to

elected government had been disappearing since the end of the Eisenhower years.

The idea of deferentially voting for a better man than the voter

was an idea whose time had gone.

Every voter had become as good as

any other man, and the elected candidate must be as much as possible a mirror image of the voter. In return for his election and his paycheck, he must accept the imposition of the voters' judgment and do the voters' bid ding in all things. This trend in the American democracy gave the voter a heady and generally accurate sense that the government was his own, but it also debased the capability of the government. Under these circumstances, the government could stand no taller than the average of its citizens, which was far less tall than the American government had historically stood. The government was reduced to a constant pandering to base motives of greedy citizens, a constant pursuit of faddist causes trumped up by noisy cliques, and a constant bartering of self-interest among strong private factions to the exclusion of the broader interests of the nation.

It was democratic

without doubt. It was more democratic than governments ordinarily were. It was also potentially fatal. It was an exact replica of the Weimar repub lic. Heedless egalitarianism destroyed the Weimar republic as surely as it destroyed the First Republic of France, or the Fourth. A little less democ racy is a stronger democracy. A little more democracy may mean no more democracy. Militancy in the enforcement of individual rights is similar. In fact, this kind of militancy is the more general phenomenon of which egalitarianism is only a part. Militancy was the spirit of the age in America, and militancy as much as anything accounted for the spreading impotence of American democratics. Militancy is no more than the vigorous assertion by individu als of rights guaranteed to them as individuals by the democratic system. If the existence of individual rights is the most sublime privilege of democ racy, and it is, then they should be all the more sublime the more militantly they are pressed. But it is not so. Individual rights can exist only so long as they lie mostly unused.

If all individual rights are to be asserted by

everyone to their ultimate extreme, there can be no rights. Militancy in the enforcement of rights is the exterminator of those rights. Individual rights are a prickly thing, like a bag of burrs.

Without ex

233

39 Democratics ception, the exercise of one man's rights is boun. to be an infringement of the next man's rights. A blatant freedom of one man's speech infringes on the next man's freedom from undue disturbance. A criminal's right to be free from unjust procedure infringes the rights of other citizens to be free from crime. Individual rights of one man can be allowed to exist only in balance with the inevitably conicting individual rights of other men, and balance can exist only if no one man insists on forcing his own rights as far as they can be forced. This is why rights are healthiest, strongest, and safest when they lie idle. From that principle owed the ancient presump tion that the man who most vocally demanded his rights probably least deserved to receive them. Immanuel Kant formulated the test for permis sible social conduct by an individual as that which all, and not merely a few, citizens could engage in without harm to the functioning of society. Militancy of rights fails that test. A small minority of citizens militantly demanding their rights can be endured, but if all citizens did so the rights must be abolished. Forbearance alone allows democracy to ow and rights to exist. Militancy destroys them both. An individual right so basic as not even to require stating in bills of rights is the right to pursue private self-interest.

A man may seek his

own interest, without required concern for any other man's interest, to the absolutely ultimate extreme that does not violate a law. That is a broad freedom.

A man may strike, he may agitate and protest his living and

working conditions and the goods that he buys, he may combine with other citizens in lawful coercion of third citizens, he may sue anyone he chooses with or without cause, above all he may petition and lobby his government for special advantage to himself that other citizens do not have.

Other

individual rights a man may exercise only occasionally in a lifetime, but self-interest is what he pursues every day and most of the hours of his life. This pursuit of self-interest is not in the least a vice, but truly the engine that moves the system eciently forward. Harnessing self-interest is the heart of the political problem in an eco nomic crisis like ination. The self-interest of each group must balance with that of all others and not militate against them. But the government can not harness self-interest; only the people can. The government can propose and enlighten, but the people must accept. In an economic diculty like ination, the problem of adjusting self-interests is the problem of persuad ing each segment of the people that action which appears to be opposite to

234

their short-term best interest actually serves their longer-term best inter est. It is the problem of persuading workers that conditions which prevent wages from rising are better, even for workers, than skyrocketing wages. It is the problem of persuading capitalists that better distribution of pur chasing power from capital to other citizens is better, even for capitalists, than letting them hoard it. It happens that the longer-term best interest of every group is harmonious with that of every other group, and there is no conict, but that is hard to see. It is not a matter of altruism but of more sophisticated self-interest. It is not a matter of being more humanely considerate of the other fellow, but of being more shrewdly considerate of oneself. But all that is hard to see. Militancy in the pursuit of no right is more mortally damaging to free democracy than in the pursuit of self-interest.

Self-interest in a demo

cratic and libertied system like the United States resembles a sort of radial tug-of-war, each citizen holding a single rope that is anchored to all others at the center of force, and each citizen at liberty to pull on his own rope as strongly as he wishes in order to draw the center of force of the entire system toward himself. The right to pull is an attractive right, but only so long as no one exercises it. If more than a few citizens pull, all others must pull also to protect themselves from having the center of force pulled away from them. And if all citizens at last are forced to take up their ropes and pull with might and main in self defense, the system is immobilized. Each citizen then is exhausting himself to accomplish nothing more than if all the ropes had been left slack, but only to avoid being beggared by his fellow citizens. The ability to pursue self-interest has been eectively destroyed. Militancy destroyed it. Governments are nominally in charge of what their nations do, and in ation in particular is caused by governments and preventible by govern ments, but the ultimate responsibility for what governments do lies with their people. It is too comforting to blame "the government" or "the politi cians." Every nation gets precisely the quality of government it deserves. Every government, even dictatorship more than is generally supposed, is the creature of its people and not the reverse. Candidates for government do no more than oer a product for the people to buy.

Anything that

the people would buy, some candidate will be found to oer.

Good gov

ernment reects credit on either the sagacity or the sound instinct or at least the deference of the people. Bad government likewise reects more

235

39 Democratics discredit on the electorate than on the elected representatives, just as the existence of pornography reects more unfavorably on the audience than on the purveyors. Contrary to the view that the United States itself tended to take, democ racy is not a form of government for all peoples. The instinctive understand ing that rights can be honored only in moderation is what marks a people capable of democracy. Such peoples are rare. The United States had been such a people for two centuries, but it remained to be seen whether it continued to be so. In the toils of the great American ination, the demo cratics of the system were not working well. Excessively egalitarian, riven by militancy, paralyzed by self-interest, blithering of individual rights, and therefore weak  in this state of readiness the American democracy con fronted the supreme challenge of ination. It was an exact likeness of the state of readiness in which that other most democratic of democracies, the Weimar republic, faced the same test, and it might all too possibly forebode a similar failure.

236

40 Political Reorganization The end of the road for a government that fails to control its economic problem is political reorganization. There is no other alternative. If gov ernments do not nd a way to liquidate inations, inations have a way of liquidating governments.

A business corporation that fails to control

its economic problem can become bankrupt and go out of business, but a nation cannot go out of business. It is obligated to exist. It must either succeed or reorganize.

Political reorganizations may take any form from

armed revolution to orderly constitutional remodelling, but their one com mon requirement is that they produce a dierent kind of government that is strong enough to control the economic problem. The terminal inationary conditions that compel a political reorganiza tion to take place are familiar. No mere short temper on the part of the people brings on the upheaval. Quite the opposite. People show a long-suf fering reluctance to resort to political reorganization against incompetent government. When the majority of people nally resonate to Hitler's judg ment of the existing democratic government as "parliamentary bedbugs," or to Charles de Gaulle's contempt for "parliamentary immobilisme," and not before, will the existing government be dismissed. What drives people to this is nothing less than a breakdown of the economic system for pro viding the necessaries of life. In an ination, this happens when a helpless government, trying to ee from hard times and at the same time to over take price ination, takes each new step of the geometric money ination so often that it nally stumbles into the German ending. The people become convinced that the ination will never cease to worsen, and they then spend their money so fast that the ination redoubles again and again. Money wealth is quickly erased, but still the ination is unsatised. Controls are imposed on everything, but that merely dries up the supplies of everything. Normal business breaks down, and people lose jobs at an accelerating pace. Money, in spite of its surfeit, is scarce, scarce, scarce. Every kind of spend ing that can be eliminated, is eliminated. The most dispensable activities,

237

40 Political Reorganization like culture, charity, comforts, and education, go rst.

Useful but tem

porarily dispensable values like housing and clothing go next. Last to go, naturally enough, is food. Barter can take the place of a destroyed money system to some extent, but in a highly developed and specialized system too many of the people are too far removed from the sources of subsistence to enable barter to keep them going. When the food goes, and usually not before that, does reorganization come. Great inations are traditional causes of political upheavals. History is strewn with the carcasses of governments that failed to control inations. This is how Lenin's famous judgment, that the best way to destroy the cap italist system is to debauch the currency, comes to fruition. Irving Fisher quoted a French aphorism, "After the printing press, the guillotine," which of course alluded to the bloody terror that followed the assignat ination of the French Revolution. As Napoleon ultimately followed the assignats, so Mao Tse-tung followed the Chinese yuan ination, the dictatorship of Stre semann and later Hitler followed the Reichsmark, and Charles de Gaulle followed another ination of the French franc. Political reorganizations are of course not all bloody.

The classic case

that was not bloody was the temporary dictatorship of Chancellor Strese mann in Germany that ended the ination. Charles de Gaulle's constitu tional remodelling was another.

Germany's voluntary submission to the

fatherly authority of Konrad Adenauer for many years after World War II was another. Even the shift of power to President Roosevelt in the Amer ican Depression was a subtle kind of political reorganization, responding not to an ination but to an entirely comparable economic emergency. Besides ranging from bloody to bloodless, political reorganizations may be of any political persuasion, leftist like Mao or Lenin, rightist like Napoleon or Hitler, or centrist like Stresemann or de Gaulle. Very often each political wing will be in the running when reorganization impends, as for example when both the leftist Communists and rightist Nazis were in the streets in force at the very moment in

1923 when the centrist Chancellor Stresemann

snatched the dictatorship from them both. Political reorganizations thus are dierent, but the more they are dif ferent the more they are the same. In every case, the shift must be from weaker to stronger government, from more democratic to less democratic process, and from more diused to more personalized power. Inability to act was what caused the failure, and inability to act is what must be cor

238

rected. In the nal throes it is technically no more dicult to overcome the ination than it ever was, but that fact alone does not overcome the ination any more than it ever did. Desperation was needed to reconcile the nation to harsh medicine, and in the nal throes desperation is in good supply, but unfortunately even desperation alone does not overcome the ination. The political reorganization that does it must be radical. It may be bloodless and it may be centrist, but it cannot cling to the old middle of the road without drastic change. Centrist does not mean that. To be centrist is merely to forsake the illusory idea that one class of citizens can prosper for long while other classes do not. Drastic change is essential, and that is radical. The programs of Stresemann, de Gaulle, or Roosevelt were all more or less centrist, but they were also as radical as any Communist or Nazi revolution, and the political reorganization that successfully brought the American ination to a conclusion would have to be no less radical than any of them. Political reorganizations often represent opportunities for the future as well as failures of the past.

A new and better building can be built on

the ruins of a disaster site more easily than the old building could have been renovated. It is a harsh fact that collapse may be necessary to permit progress to occur. Desperation does not automatically increase the ability to move forward, but it does tend to decrease the will to resist. Making the most of the opportunity oered by a political reorganization depends on the historical accident of what man happens to be standing in the way of the reorganization and inherits its leadership. It is largely a matter of luck. Germany enjoyed a spectacular improvement in fortunes when the dictatorship that ended the ination in

1923

fell to Gustav Stresemann.

Germany was less lucky with the political reorganization of Adolf Hitler. Charles de Gaulle was clearly a stroke of improved fortunes for France. The United States had poorer luck with Franklin Roosevelt. As political reorganizations go, there are good ones and bad ones.

The rightist and

leftist ones are nearly always bad, and the centrist ones can go either way. The political reorganization that might lie at the far end of the Amer ican ination was still a completely blank slate in no dearth of leftist forces waiting to take charge.

1973.

There would be

There never is.

Like

insects, leftists are always about. Virtually all radical currents of thought in America were dominated by generally socialist and Marxist ideas. The accession of these forces to power might be more like the bungling Salvador

239

40 Political Reorganization Allende of Chile than the ruthless Lenin of Russia, but in either case the termination of the traditional liberty and prosperity of America would be equally certain. At the other pole, rightist forces in the United States were hardly more than vestigial.

The United States had no tradition of mili

tary coups and seemed unlikely to develop the taste. The United States enjoyed a long history of being politically phlegmatic. Americans were not a people to take to the barricades. In

1973,

Americans were not exactly

the same kind of people they had traditionally been, but their political in ertia might still steer them between left and right to some kind of political reorganization of the radical center. Looking into the mists of the future from

1973,

one could see nothing

clearly of the denouement of the American ination.

It was dicult to

believe that anything so drastic as political reorganization must eventually become necessary, but it was equally dicult to believe that it could be avoided.

It was dicult to believe that any government, knowing what

it was doing, could be so foolish as to take the next step upward in the geometric ination, but it was equally dicult to believe that any govern ment could resist the tremendous political pressures to take just that step in ight from hard times and pursuit of prosperity.

If collapse and reor

ganization required that the government continuously fail to take eective countermeasures, the government could be fully trusted to fail to take them. If collapse and reorganization required that the government from time to time increase the inationary impetus, the government seemed ready to supply it. If ignorance was indispensable to an inationary collapse, igno rance of the requisite kind seemed to be one of the nation's most abundant remaining resources.

Political reorganization in the eventual future was

altogether more probable than it should have been.

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41 Self Defense An individual caught in an inationary vortex has one primary concern, and that is what he can do to defend himself.

As an individual he has

no power, there is nothing he alone can do about the democratics of the situation, and the reasons why the situation has developed are of only faint interest to him. Finding shelter is his need. When the state loses its ability to defend all its citizens impartially, defense becomes a matter of every man for himself. Self-defense in an ination is essentially the defense of property.

An

individual's person is not in danger, except perhaps for the violence that sometimes accompanies political reorganization. An individual will be the same person after an ination as before, except perhaps for the anguish which may scar him permanently. It is his property that is the prey. If he does not have property in the sense of stocks or savings, he usually does have a calling in which he may have invested much of his life for training and experience. That is property of an intangible sort and an investment of the most important kind. Ination stalks his property with the sole object of devouring its value. Self-defense consists of emerging from the ination holding intact some part of the property value that he had formerly thought he had. Successful self-defense in almost any ination is not an impossibility. It is not easy but not impossible. There are, however, one or two rather gloomy aspects of the search for self-defense. One is that there is no sure safety anywhere. There is no safe refuge where one can hide for the duration. The defense is, as they used to say in war, uid, and it must change from day to day. The second gloomy aspect of self-defense is that loss will predominate over gain. Almost all kinds of investment property are inated in price in an ination and must therefore suer some erosion of real value before the ination is over. The object of self-defense is to minimize the erosion. It is true that for every loser there is a gainer in ination, but it is the holders of property who are the losers and others, such as debtors and spenders, who

241

41 Self Defense are the gainers. Making any real prots in a dying ination is practically out of the question. With clairvoyance or hindsight it could be done, and there were probably a few Germans who did do it, but anyone who dares try to play a decaying ination for anything but defense against loss is playing a perilously greedy game. The very idea of self-defense of property in an ination necessarily as sumes that an operating economic system, preserving rights of private own ership of property, will survive the ination.

That assumption is by no

means assuredly right. The German system did survive the chaos of but the Russian system did not survive the chaos of

1917,

1923,

and whether

the American system would survive the chaos of the American ination was not known. If it would not, self-defense of property would have been in vain, but there was nothing much that could be done about it, and so one might as well prepare a self-defense on the assumption that the system would survive. The universe of investment property has many classes, all diering from one another in their vulnerability to ination. They include at least the following: bonds, bank deposits, and other paper wealth denominated in money; common stocks and other ownership interests in industry or prop erty; land and other real estate; goods and other tangible personal property; and foreign money or gold. Money wealth was by far the largest part of investment property in the United States. Total debt exceeded $3.2 trillion and was growing rapidly. Money wealth had traditionally been the safe haven in economically par lous times like the Great Depression, and that was why owners of property were to be found preparing their self-defense against the last previous de pression.

In the ination, however, money wealth had become not the

safest but the riskiest, most speculative, and probably worst possible form of investment. It represented the most assuredly guaranteed loss. Money wealth was the mine that ination stole from.

If the ination went on,

money wealth was what the ination would destroy. Shorter-term money wealth was less terribly vulnerable than longer-term  money due in thirty days cannot lose as much value in that time as money due in thirty years  but all money wealth was nakedly exposed to the assault. It was im material how solvent the debtor might be; though it be General Motors or the Federal government, the debt was unsafe. No person in his right mind would have been found investing in xed money wealth at the paltry pre

242

vailing interest rates of less than

10 percent in 1973 if he could have known

with certainty that money wealth was bound to lose its value by at least the

22

percent of the Index of Latent Ination, plus the

6.5

percent per

year ination that the government was forced to sustain continuously plus whatever increased ination the government might have to try in order to stave o recession.

Certainty is of course an elusive thing.

Probabilities

are what people must be content with, and those were the probabilities. In view of those probabilities, the tranquility with which hundreds of billions of dollars continued to ow into straight dollar debt without the least form of protective escalator against ination was truly astounding. Any general exodus from this straight dollar debt, on the other hand, would of course signal the beginning of a breakdown of the ination structure. All of this would be quite dierent if money wealth were "indexed" against ination.

If General Motors or the Federal government, for ex

ample, oered a mere

4

percent bond, with each payment of interest or

principal to be multiplied by the factor of increase in the wholesale price index since the bond was issued, that bond would be reasonably secure against ination.

It would be as close to a safe haven from ination as

could be devised. It would clearly be preferable to a

10

percent or even

15

percent non-indexed obligation of any debtor. Such bonds were widespread in the late German ination and were in fact remarkably solid in value. At the time of the American ination, they were also widely used elsewhere in the world but unknown in the United States. If any general ight from ordinary dollar debt developed, so that straight dollar bonds could not be marketed, the run could easily be stanched by oering indexed debt in its place. If indexed debt did become prevalent, the government's ability to nance prosperity with ination would be at an end, but that was the gov ernment's worry. Until indexed debt did become prevalent, money wealth was no place to attempt self-defense in the ination. Money wealth was ground zero on ination's target range. Foreign money, especially the American dollar as irony would have it, had been the safest refuge a German could seek in

1921 and 1922.

In

1973,

there was some appearance that foreign money like German marks or Swiss francs might be a safe refuge for an American to seek, especially in view of the successive devaluations of the dollar that had steadily increased the value of foreign currencies in recent years. was accurate, but probably it was not.

Possibly this appearance

Foreign money is a safe refuge

243

41 Self Defense from ination only if the foreign money's government will defend its value from ination more successfully than one's own government. In

1922

the

American government did, but there is never any very rm assurance that any government will. The American dollar in

1922 was as solid as Gibraltar,

and the economic troubles of Germany and other countries were but ripples lapping at its base.

In

1973,

no currency was like that any longer.

The

lingering strength and stability of the German mark were largely residual from the remarkable management of the Christian Democratic party, under men like Konrad Adenauer and Ludwig Erhard, that ended in that Germany began inating as merrily as anyone. By

1973,

1966.

After

hardly any

nation on the face of the globe was doing an even minimally competent job of maintaining the value of its money.

The earthworks had all been

swept away, and all were oating along on the ood together. One or more foreign moneys might conceivably do a little better than dollars, or they might all do worse. It was anybody's gamble. Gold, the international money, was a special case. Throughout the eons of the world, gold had been the classic refuge of owners of property trying to defend it from economic slings and arrows. But, like everything else in an ination, gold was overvalued. It was overvalued even before the ination began.

Gold yields no income and costs money to store and handle.

is not very useful.

It

If the American Federal Reserve System should no

longer accept gold as international money and people in general should turn against gold for that purpose, its intrinsic value for industrial and commercial purposes could not have been more than a small fraction of its prevailing price. Most of the value of gold lay in that people expected it to have value, and that value could last only as long as the expectation. That expectation had endured over thousands of years, and it might endure forever. Or it might not. It was anybody's gamble. Real estate is a classic hedge against ination. The name is apt. Real estate is a real value. The intrinsic value of real estate is indestructible, except by depreciation or physical damage. If a man owns a piece of land to live on, it is equally good for living on before, during, or after an ination. Its intrinsic value for living on is not aected by prices, even land prices. As an investment, however, the value of real estate is not so invulnerable. The value of real estate for investment depends on its market price and not merely on its continued usability for a particular purpose. In an ination, prices of real estate are as inated as any other prices, some kinds of real

244

estate more than others.

Real estate as an investment is by no means

neglected in an ination, and its quality as a real asset is by no means unnoticed.

There are usually no price controls on real estate, and there

are no natural restraints like foreign competition to hold down real estate prices. Real estate prices therefore inate more rapidly in an ination than do other prices. From those inated levels, real estate can easily fail to hold its relative market value as other prices rise. Particular kinds of real estate which may have been especially favored by the inationary prosperity, such as luxury dwellings and overblown commercial developments, conceivably might be even more prone to lose real value in the breakdown of an ination. Real estate thus has no broad immunity from all loss of value, even though real estate is more real and less capable of loss than, say, money wealth. A some is still a home no matter what, but beyond that real estate is right out in the battleeld along with all other forms of investment, ghting to defend itself. Farmland is a special category of real estate.

There is more farmland

than any other kind of valuable real estate, and farmland is possibly the most bedrock of all real values because it produces what people must have, ination or no, in order to live.

Farmers thrive and the value of farm

land excels in the dying throes of every ination, and the great American ination would probably be no exception. But even farmland as an invest ment has its own special diculties.

Although farmers and farmland do

strikingly well in late inations, they tend to be somewhat less prosper ous than the rest of the nation in early inations or in normal times. No parcel of farmland is like any other, but each suers the individual perils of geographical place, including oods, storms, and the other vagaries of weather. And farmland ownership in the United States was not organized to receive large amounts of outside investment. Most farmland was either owned by or leased to a farmer  that was why American agriculture was so phenomenally ecient  and there was no ready way to buy a share of a farm or a farmland fund, as there was of a steel company or a mutual fund. Farmland was vast and its value would endure, but it was, as they say, spoken for. Useful goods are one last kind of property that will ordinarily keep its value through an ination although it is not generally thought of as a form of investment. If all other kinds of investment will have diculty holding their value in ination, it must be because the prices of goods will rise

245

41 Self Defense faster than the prices of investments.

It follows that goods would be a

better investment than investments are. Theoretically, this is true. Any German could have made himself quite rich by acquiring a large store of underpriced food or other goods in

1920

and then trading this store later

in the ination for houses, stock of solid industries, or whatever other real assets he might fancy at ridiculously low relative prices. The possibility of investing in tangible goods is, however, more theoretical than real. A nation produces only enough of these goods for current consumption. Using them for investment is hoarding, and if any signicant part of the current out put were hoarded for investment the ensuing price ination would quickly remove the advantage. In addition, as with gold, there is a cost involved because goods produce no income, incur storage and carrying charges, and require a distribution system to be resold. Goods can serve as a protable investment only in the one specialized eventuality of a catastrophic ina tion coming within a very short time, and that eventuality is never assured enough to be relied upon. These possible foxholes of defense against ination, ranging from pro hibitively bad ones to plain bad ones, mediocre ones, and theoretical ones, leave only one large remaining battleground on which to take a stand. This battleground is the stock market, and it requires a chapter of its own, which follows.

246

42 Self Defense Continued: The

Stock Market

The stock market in the United States is a vast place. It consists of bil lions upon billions of pieces of paper ownership of the industrial might of America, passing from hand to hand in a few strange ballroom-like markets around the country. The pieces are paper, but the stocks are real assets unlike money wealth, as real as any land, as real as a part interest in a drop forge or an electric steel furnace. And, apart from money wealth, the stock market is the only receptacle huge enough to accommodate all the wealth of the nation that might be seeking investment. The stock market not only is vast but is well patronized in an ination. The stock market is the original home of inationary madness in the early phases of any ination. Later the stock market may fall into disrepute, but that is as misplaced as the original madness. Besides earning easy riches for everyone in early booms, common stock always enjoyed a traditional reputation as a secure hedge against ination. By

1973, however, disillusion

with common stock had set in in the Unite States. As other prices went up, stock prices went down. That was a strange way for a hedge against ination to act.

Common stock's traditional reputation as a hedge was

widely discredited, and a general aversion to common stock investment took its place. It was all very perverse, but it was all very familiar. It was not at all inconsistent with the reality of common stock as a repository of value. The strange behavior of stock markets is not nearly as inexplicable as it is often thought to be. Stocks in a market are merely one of the kinds of values that can be bought for money, and the prices of stocks are no dierent from the prices of any other articles of commerce. Like all prices, stock prices are not sacred cows that rise and subside at their own whim and without answering to any law. The stock market dances to an inaudible tune that is played for it by the government's money ination or deation,

247

42 The Stock Market just as all the members of society dance to the same tune every moment of their everyday lives without being able to identify the source. A man who fully understood what ination was doing at all times would seldom be surprised by the stock market.

Armed with that understanding and

little else, he could participate protably in every stock market rise, step aside safely from every stock market fall, and shepherd his property with reasonable security through the bombardment of ination or deation. The stock market without ination would be a sleepy place.

Without

ination, prices in a stock market would be steady, like other prices, and moreover they would be steadily low by standards of the American ina tion. There would be little reason to trade in stocks, because tomorrow's price would be much like today's. general capital gains. in America, like ination.

1948

Without ination, there could be no

All of this was proved in those few brief periods and

1954,

when there was a real absence of money

It must come as a blow to those who invest their lives or tie

their fortunes to the hope of rising prices of investments, and the blow to them is regrettable, but a booming stock market is no necessary part of an economically healthy nation. Capital gains are no part of real prosperity. More nearly the opposite is truer A rising stock market is a danger signal of the rst order, and a falling stock market is a sign of returning reality. A low and stable stock market may not be good for speculators, but it is good for the owners and accumulators of new wealth seeking to buy liberal real values at reasonable prices. The stock market as a whole rises because there is money ination and for no other reason, and the stock market declines because there is a weakening of the money ination. Business prosperity and price ination also respond in the same way to the same impulses, but at much longer time intervals, and that is why the stock market frequently goes the opposite way from them.

When the government rst turns on money ination in times of

slack business, the money has no work to do yet and nowhere to go but into investment markets.

So the markets rise, even though business is

still bad. Later on, as business begins to hum and prices to rise, some of the inated money must be sucked back out of the investment markets to service the business prosperity. So the markets fall. As other prices go up, stock prices go down. When business is worst, stock prices rise most; and when business is best, stock prices decline. A rising stock market signals nothing but freshening money ination. It is the earliest and most sensitive

248

indicator of the inationary train of events to come. Conversely, a declining stock market is nothing but a returning of stock prices from inated heights to their base of real value.

The stock market is at its base of real value

only at the fully deated market bottoms which occur after a reasonably prolonged absence of money ination, in company with rather depressed business. Whenever stock prices have risen above these bottoms, they are inated.

If stocks are bought at those prices, losses can be condently

expected whenever prices fall back again to real value in the future. Stocks bought at any point above their real-value bottoms are not a hedge against loss, but a guarantee of loss. On the other hand, stocks bought at real-value bottoms have good prospects of holding their value in all events including ination. The levels of stock market bottoms bear a strong proportion to the prevailing levels of money ination. For example, the American stock market's deated bottom in than its deated bottom in was larger than in

1962.

1970 was precisely the same percentage higher 1962, 43 percent, as the money supply in 1970

So long as this relationship holds, the prices of

stocks bought at the bottoms can be trusted to rise and thus keep their value at least as fast as the money supply and therefore the equilibrium prices of other things. This ability of common stocks to oat upward with equilibrium prices is what distinguishes common stock from money wealth, making common stock potentially a hedge against ination while money wealth is ination's chief prey.

An example may help explain this dierence.

Suppose ABC

Corporation, which manufactures something useful, has sales of $100, costs

of $90, prots of $10, and pays out $5 in dividends to its stockholders.

Its stock might perhaps sell for $100 in the stock market.

If there is an

ination, and all prices including those of ABC double, all other conditions being the same, ABC will now have sales of $200, costs of $180, prots of

$20, and will be in a position to pay out dividends of $10 to stockholders. The $10 dividend will buy the stockholder just as much in food or clothing

or rent as the old $5 did. The price of the stock in the market may also

have increased to $200, and the stockholder has suered nothing from the twc-fold ination. If he had bought a

5

percent bond of ABC Corporation

for his original $100, ABC would still owe him only $100 and $5 a year in interest income, both of which would be worth just half as much in food or clothing or rent as before the twofold ination. A common stock can oat upward on an inationary tide like a boat, while a debt investment, xed

249

42 The Stock Market in place, sinks deeper under water as the tide rolls in. A degenerating ination may distort things wildly for a time. The stock market may come to seem a very lonely place, and the faith of a believer in common stocks may be very sorely tested. Germany was an example of this. When ination began to run away, the prices of stocks not only collapsed back to real value from their inated peaks, but for a long time they did not rise again even while the prices of other things were soaring.

This

meant that the real value of stocks in terms of other goods was constantly decreasing, even though their money prices were not. The reason for this was fear. Condence disappeared, and no one could feel sure enough that any business would survive to want to buy its stock. In the end, faith was rewarded. Stocks did recover and emerged from the ination being worth about as many pecks of potatoes as they had been worth after the rst crash. The stock market can go the other way in a degenerating ination as well. Germany showed that too. When a law was passed forbidding Germans to invest in foreign money like American dollars, there was no place for money to go but the stock market, and the stock market had its most astronomical rise ever even while business was in its worst state of collapse. Something similar might happen in the American ination if trust in the money wealth should break down and there was nowhere else for the purchasing power to go but the stock market. At these times, the stock market is overpriced again and is sure to relinquish some of its paper gains, but if there is nothing more valuable to buy stocks remain the best thing to hold. What is true of the stock market as a whole in an ination is not true of every stock in it. The stock market represents real value, but not every stock does. Far from it. The American stock market in the ination dressed up many of its emptiest bottles of air as the most glamorous bulwarks of investment value.

This is not unique, but characteristic.

stock market in the boom of

1920

and

1921

The German

was even slightly crazier, but

only slightly. The cult of the capital gain in both markets exalted rising prices over old-fashioned values such as earning power or dividend yields. Rising prices begot further rising prices. Individual stocks that became the darlings of capital gain cultists rose to prices much higher than the market, and much higher than their real value in conditions of stability could justify. They could not help but lose value back to that level. Many other kinds of businesses and the prices of their stocks had been disproportionately

250

favored by the unnatural prosperity and the unnatural activities of the ination, and they too could not help but lose real value if the ination broke down. On the other hand, many of the most useful and basic kinds of business had been relatively disfavored by the ination, their stocks had suered accordingly, and in the purging of the ination both their business and their stocks' values could be expected to improve at least as much as the prices of goods.

Successful self-defense in the stock market was

a matter of projecting oneself mentally into the post-inationary world for a look around, seeing which businesses would thrive as well as ever and which would not, and then returning to ination's midst to buy the stocks of companies which would be thriving later and were doing at least passably well even then.

As dierent as the post-inationary prosperity

would be from the inationary kind, just that dierent would the thriving businesses of that time be from those of the inationary era. As had been true in Germany, there was a strong suspicion that many of the last might become rst, the humble exalted and the exalted cast down, but beyond that suspicion any man's guess was as good as the next man's. Much the same kind of reasoning applied to that most important invest ment most men ever make, the investment of their lives in the training and experience necessary to their life's pursuit of some trade or profession or other line of business. Ination misleads men as cruelly in that investment as it does in the stock market, and the harm it does by that deception is some of the saddest harm of all. The American stock market was a vast place, vast enough to take in all the refugees that might seek it.

There was safety there too, somewhere,

if it could but be found. Safety would not be easy to nd, and some loss must be expected, but survival was possible. The tides of ination were what governed everything, and if a man could understand them and be prepared to move his place of defense from day to day, he could probably weather the storms. Attempting to make prots from the stock market, or even to make sense of it, without completely understanding the universal determinant of ination was like being at sea among uncharted rocks and shoals without so much as a tide table. Reasonable men might dier as to what it was that controlled their destiny, but if they placed their trust in some other force they had better be right.

251

42 The Stock Market

252

43 A World of Nations The United States did not struggle in a vacuum with its economic problem. There was another whole world of nations beyond its shores, and many of those other nations were keenly interested spectators and also unhappy participants in the struggle.

More than any other nation, it is true, the

United States and its economic problem were virtually self-contained, and this made the American problem simpler and purer than it would have been elsewhere. It did not alter the fact that the American ination assumed for itself a worldwide consequence. Internationally, the American ination was the transmitter and the rest of the world the receiver. The United States was the actor, and the rest of the world the audience. Other nations were forced to participate only because the action spilled out of the stage and into the orchestra.

The

United States was the author and the cast, and it held the power of control of the worldwide problem for better or worse. Ination's courier to the rest of the world from the United States was money.

Just as ination is a disease of money, the bearer of contagion

outward from its source is an outow of money.

The constant outow

of dollars from the United States implicated the rest of the world in the American ination, as an outow of Reichsmarks had implicated the rest of the world in the German ination. One striking implication, identical to that of the German ination, was to leave foreigners holding a staggering portion of the dollar money wealth which was waiting to suer future losses in the ination.

Virtually the entire growth of the Federal debt of the

United States after

1967,

or $55 billion worth, was involuntarily nanced

and acquired by foreigners. By

1973,

foreigners' holdings of liquid dollar

debt from all American sources had risen to more than $90 billion from

only about $31 billion in

1966.

More unwelcome by far than the tainted dollar debt was the export of ination. America's export was the rest of the world's import, and it was shipped by means of the same outow of dollars that carried the tainted

253

43 A World of Nations debt abroad. Europeans had complained for years that the ination they suered at home arose by import of the American problem, and in that they were entirely correct. Ination had become the United States' principal, and by far its most protable, export. Another name for the outow of money that carries an exported ination from its sources, like the United States, to its victims, like the rest of the world, is a balance of payments decit. A balance of payments outow is a perfectly normal and logical eect of an ination in one country. If there is more money around in the rst country than is needed to service all its normal purchases and sales, some of the surplus money must naturally go abroad looking for the good things that can be bought cheaply there. There is a strong tendency for money to ow from a country of surplus money, or ination, to other countries of no surplus money, or non-ination. The correct cure for a balance of payments decit is as simple as the cause: stop the ination at its source.

This, however, is not desirable to the source

country because of all the good things that ination does for it, including easy and pleasant buying at foreigners' expense. The balance of payments decit is entirely benecial to the decit country.

Contrary to popular

protestations of disMay, it has no ill eects whatever.

The money that

has departed the country reduces, dollar for dollar, the pressure toward price ination at home, while the export of the inated money brings in real values from abroad fully as eciently as the export of any real goods would do. That was why the exported ination soon became the United States' most protable export. Central bankers had an ingenious system for recycling payments decits so that they could go on generating ination almost innitely throughout the world on the basis of the recycled dollars. Every surplus dollar that moved abroad generated an inated number of Deutschemarks or Swiss francs from the German or Swiss central bank in payment for the dollar, but then the central bank took its newly-acquired dollar and lent it back into the United States so that the surplus of dollars there was as large as ever. The same dollar could ow out and generate money ination in the rest of the world as often and as rapidly as the central bankers could recycle it back to the United States. Here enters the matter of foreign exchange rates. Foreign exchange rates are the relative values between one currency, such as the dollar, and an other currency, such as all the others.

254

They have a considerable part to

play in this. Recurring exchange rate crises, with their attendant specula tive ows of money from one currency to another, were the most visible manifestation of the problem in the advancing years of the ination. They were so familiar, in fact, that they came to be thought of as being the prob lem itself. They were not. They were only by-products of the American ination. Foreign exchange rates are an incredibly complex mechanism, governed by incredibly complex forces, much more so than the general price level in a single country. The one important thing to remember about the foreign exchange rate of any currency, however, is that, like prices themselves, it does have at all times a single natural level which it seeks in opposition to all external forces, including exchange rate controls and speculative attack. The exchange rate of any currency cannot be driven arbitrarily high or arbitrarily low without releasing powerful forces pushing it back toward its natural level. Lord Keynes elaborated the theory of foreign exchange rates on a basis of "purchasing power parity," which means that the exchange rate between two currencies must tend to stabilize at the point where the purchasing powers of the two currencies in their own countries are equal to one another. This is logical. If the exchange rate of one country's currency is unnaturally low, making goods and other things relatively cheaper in that country than elsewhere, money would naturally ow in from other countries to buy those things and drive uf the exchange rate. And vice versa. The foreign exchange rat of a country's currency is therefore a function of the price level in that country. Just as foreign exchange rates are a function of price level, changing for eign exchange rates are a function of changing price levels, more specically ination. When one countr inates its money while others do not, its price level will eventually rise, but not immediately; before that, the foreig ex change rate of its currency should fall, because there is more of the surplus money seeking to go out of the country thar hard money seeking to come in. Since internal prices are slower to act, this makes the exchange rate un naturally low at rst, and the prices of goods unnaturally competitive, and this in turn brings demand from abroad which helps to drive internal prices up to their new inated equilibrium. All of this is precisely the sequence of events that transpired in Germany of

1922.

Since the falling exchange rate

preceded the price ination, people blamed the falling exchange rate for the price ination, never noticing that the money ination had preceded

255

43 A World of Nations them both and caused them both. Foreign exchange troubles are a prod uct not merely of ination but of dierent rates of ination in one country than in another. If all countries are stable and avoid ination, there will be no stress on their existing exchange rates, that is plain enough; but they will also be equally free from exchange rate troubles even if they are inating, provided that they are all inating at the same speed. The ex change rate crises of the early

1970's

were a product of the days when the

United States was gaily inating while other important industrial nations, notably Germany, were resisting. As their resistance was broken down and they all joined in surng on the inationary wave, the problem of exchange rates might well go away and leave them only the much greater problem of unchecked worldwide ination. Most of the time after World War II and the adoption of the Bretton Woods system, foreign exchange rates of Western nations were not a free market as they were at the time of Germany's ination, but instead a sys tem of xed rates which were a form of price control. Fixed exchange rates complicated the problem, and they hampered coping with the problem, but they did not create the problem. Fixed exchange rates for a while intro duced some abnormal stability into foreign exchange, but they made the crises worse and they also made it possible for an inating country like the United States to export its ination and enjoy the benets of its ination at the expense of other countries. Like any other form of price control, xed exchange rates could not for long prevent exchange rates from answering to natural forces. By

1973

and the onset of the permanent "oating" ex

change rates, the system of xed rates had broken down for all practical purposes.

This brought back a freer market for foreign exchange similar

to what surrounded Germany.

In so doing it brought back the natural

falling exchange rate for the inating currency, the dollar; it brought back the naturally abnormal foreign demand for American goods made cheaper by the falling exchange rate; and it brought back the upward pressure on internal American prices caused by the abnormal foreign demand. Foreign exchange rates are not as baing as they sometimes seem. Ex change, rates are simply an adjustment mechanism for the problem of in ation, and not a problem in themselves. Exchange rates can adjust cor rectly for any conceivable combination of forces if they are but allowed to do so.

Banishing ination would be the surest way to banish exchange

rate problems.

256

Everyone inating in unison would also banish exchange

rate problems.

Failing both of those, nations could also avoid exchange

rate problems if they either learned to manage changing exchange rates properly or allowed exchange rates to manage themselves to adjust for dif ferential ination. Central bankers, those little-known gnomes who preside over the inter national relations of money, tend to have several kinds of shortcomings of understanding that impede their ability to do their job. The rst is that they do not understand ination very well, but then no one else does ei ther. The second is an obsession for exports. The third is an obsession for reserves and a balance of payments surplus. And the fourth is an obsession for gold. Among them, these four managed to becloud the vision of central bankers quite completely in the exigencies of the American ination. The failure to understand ination was nothing unique to central bankers. It was important, however. If central bankers had been able to spot money ination developing in some other country, knowing that a payments out ow and a downward pressure on its exchange rate would soon come, they could have contrived to manage those forces instead of having those forces manage them.

But if ination is dicult enough to analyze correctly in

one's own country, it is all but impossible to analyze correctly in someone else's country.

So this theoretical possibility was still many years away

from becoming a realizable fact. The obsession for exports was even more important. The obsession for exports translated itself into an aection for reducing the foreign exchange value of one's own currency, which meant devaluing it, and a horror of increasing or revaluing it. A lower exchange rate made one's own exports more competitive in the world, and that supposedly was good. A higher exchange rate made one's own exports less competitive, and that suppos edly was bad. This reasoning was entirely upside down and false, and it was the principal reason for the nations' inability to cope with internation ally imported ination. No nation can hope to exist free of ination -while ination rages elsewhere in the world without accepting and even seeking a constantly rising foreign exchange rate for its own currency. Once a na tion learned to accept that fact with equanimity, its problems of exchange rates and imported ination would be over. Each new upward valuation of its currency would be the signal of success rather than failure, enabling its people to buy abroad more and better things that they like with their good hard money. The rising exchange rate would necessarily foretell in

257

43 A World of Nations creasing competitive diculty for the nation's own exports in foreign trade, but that kind of competitive pressure placed on its own industries is pre cisely what holds their prices down and keeps ination out of the country. Increased demand in the other country or countries resulting from lower exchange rates is precisely what raises prices there and keeps the ination shut up where it originated. The obsession for exports which are too easily competitive at undervalued exchange rates amounts to giving away part of the value of the national product to the rest of the world for nothing, and it articially benets the export sector of the nation's economy at the expense of the rest of its own people. The United States was vivid proof that a nation gains a much easier and richer life by exporting overvalued money than by exporting undervalued goods. The rest of the world, with their zeal for giving away their product and avoiding upward revaluations of their money, made themselves willing importers of ination from, and exporters of the good life to, the United States. Central bankers' passion for international reserves was a cousin to their obsession for exports. Reserves are a nation's international money in the bank. A good corporation treasurer would pride himself on how small a bank balance he needed to transact his volume of business, but a central banker prided himself on how large a bank balance he could generate. This suggested that there was something wrong with the central banker's view. A nation's reserves arise from a balance of payments surplus, and surpluses come mainly from exporting more and importing less. Both of these are signals that the nation is allowing itself to be victimized.

International

money coming in is worth only as much as it can buy abroad immediately, and it should be forthwith used for that. A central banker should avoid a payments surplus as ardently as he does a decit, aiming always at a payments balance which is the absence of either. The most skillful central banker, like the most skillful corporate treasurer, is the one who can manage the largest volume of business on the smallest reserve balance, borrowing when he needs to for covering temporary deciencies of his working capital. Gold was the last of the central bankers' anachronistic obsessions, and the most anachronistic of them all. In times past, the passion for accumulating reserves meant more specically a passion for accumulating gold. well into the foreign exchange crises of the

1970'$,

Until

various nations were

constantly injecting the subject of gold into the exchange rate problem, thereby obscuring it as eectively as a morning fog. Other nations tended to

258

point to the inadequacy of the United States' large gold reserve to meet its far larger dollar obligations to foreigners, and say that this was the problem. It was not. If the United States had had no gold at all, the problem would have been no larger; and if it had had more than enough gold the problem would have been no smaller. Some other nations, especially France, tended to urge a return to a gold standard as a solution to the foreign exchange ills, but this absurd notion served only to hide the truth that a currency's value depends on the whole economy that backs it and not on some little pile of hoarded gold. The United States should have sold o all its gold to any nations that wanted it and then, goldless, demonstrated how entirely unimportant was gold to the value of its dollar. As the currency crises wore on with less being heard of gold, the central bankers seemed to be making headway toward shedding the old anachronism.

Fifty years earlier Lord

Keynes had correctly declared gold to be a barbarous relic, and after fty years some central bankers might be getting the message. The root of the foreign exchange problems in the world was ination in the United States. That bears repeating. If that root were cut, the foreign exchange troubles would wither away like many of the other evil plants of the ination that appeared to be unconnected growth.

But since the

thesis of this book is that ination in the United States virtually could not be permitted to stop, what then for the rest of the world? were clear.

The choices

The other nations could either erect a wall of defense and

contain the ination in the United States, or they could willingly join in and inate likewise.

Defense against the ination was entirely possible,

but joining the ination instead was what they had apparently allowed themselves to choose. Defense would have required tight money and tight economics in their own countries along with constantly rising exchange rates for their own currencies against the dollar. Every country's, eorts to mount this defense had gradually failed. Shown the way by the ination they had imported in earlier years, all nations were inating vigorously for themselves by

1973.

The ination was worldwide, and no end was in sight.

That itself was defensive, because no nation can be exploited by ination if it creates its own share of ination. If you can't beat it, join it, they say, and that the world had done. The failure of the rest of the world to defend itself from the American ination had more melancholy aspects, even for the United States. Having all the world sick would not help the United States get well. Stability in

259

43 A World of Nations the rest of the world had helped reoat Germany in stability surrounded the United States in

1973.

1924,

but no such

All of the Western nations

could quite possibly descend into an inationary breakdown together if they chose to, and that was certainly the direction they were going. They were a boatload of sailors at sea in one monetary boat, with all the watertight compartments left open so that a leak sprung in the dollar could impartially ood them all. Inating together and sinking together, they could not care much longer that the original leak had been in the American dollar. The American ination had still broader signicance to the United States and the rest of the world than merely economic troubles. The inationary instability which was impending in the United States posed the gravest potential peril to the peace and security of the world. The damage that could be done to the world's power balance if the American economic sys tem should break down in inationary turmoil was enormous. Ever since World War II, the United States had been the principal force defending all the Western nations, and not merely itself, from the widening inuence of the Soviet Union. Already, as the ination eroded the economic strength of the United States, the weakening of its hand outside its borders was plain. Military bases were closing, Americans with withdrawing, new military de sign was disappearing, and the renewal of the American military equipage was running down. The United States was visibly contracting in the world. European nations and other dependents of the United States had loved to tweak the American nose and declare their independence, but the fact was that the American strength had been the sword and buckler of Americans and friends alike. Without it, the sole and nal line of defense of everyone would be the benevolence and magnanimity of the Soviet Union. If there were those who thought that the real need for the American defense had been overstated, they might eventually see whether they had been right. Ination itself was not all there was to fear from the American ination.

260

44 Interscript The American ination, like most inations, was rather an absurdity. What the ination was being permitted to do to the greatness that had been and still could be the nation's was unconscionable. It was a rank absurdity that a nation as great and strong as the United States still was should ush itself down the drain in a ood of money as it was appearing to do. Somewhere in the dense fog of the ination, it seemed that the nation might very well have passed the crest of its long rise from the beginnings at Plymouth and Jamestown and placed its foot on the slippery slope of decline.

It was

absurd, and it was unnecessary. A nation doing that to itself resembles not only a man drowning within arm's length of an unseen shore, but one doing so with his strong arms and legs immobilized by the hypnotized belief that they are unable to move. It is absurd, but it is of just such epic absurdities of mass human conduct that the fabric of history is woven. National rise and national decline seem to be states of mind. The historic declines of one or another culture, compared with the relative durabilities of still others, were functions of the mental capabilities and values of the men that peopled those cultures. Physical circumstances did not seem to matter as much.

No mere abundance of resources could make a people

great for long, and no mere paucity of resources could make a people small. Leadership by excellent individuals could not lift a people above themselves for long, nor the reverse for poor leadership. In the nal analysis, it was the mental and spiritual state of the people that governed. It was the quality of the people that decided. When we say that the quality of the people decides, we mean the quality of the average of the people and not of selected individuals.

A nation

cannot nominate a chosen few to take its examinations, because every race and people has at least a few excellent individuals to oer. It is as if the destiny of a nation were to be decided by taking any one of its citizens at random and placing him under the pitiless glare of scrutiny to test how he will respond to the demands placed on the nation. Others who may have

261

44 Interscript thought about and trained themselves for those demands must be content to stand by and observe the test. Just as the people as a whole are the parents of their government, the people as a whole are the often unwitting masters of their own fate. A nation can do only so much as the average of its people will do or allow to be done, and that means that the average of its people either must have the superior intelligence to understand what is before them or, through instinct or inertia or good luck, must act as if they did.

History plays no favorites and knows no chosen peoples.

It

seldom does anything for any people that the average of them does not do for itself. The ination presented the American people a test like this.

No one

could decide for them what to do but only oer them choices. The American people were a unique sort of people. They were a nation of immigrants from all parts of the world. One hundred percent of the people that had made the nation what it was were of immigrant stock. collection of people had never been assembled.

A more heterogeneous The United States had

probably more of the nest people than any other nation on earth, and also at least its share of the less ne. It had evolved its populace over the course of centuries, and it was not going to have any other. In that time the American collection of people had shown many unusual strengths and very few serious failings. They had met every test. Every generation of people, however, is a somewhat dierent people. Every generation is a new test. The national state of mind that had been generated during, and perhaps by, the unrealities of the American ination was deeply dierent from the state of mind that had accompanied the American people through their centuries of growth. These unrealities had persisted for more than a generation, and the longer they continued the more deeply would the new state of mind be rooted. It is at least arguable that the new state of mind was not consistent with anything but decline. It is at least a possibility that the only way the United States could back away from the decline opening before it was for its people, acting through either understanding or instinct or luck, to turn and go back. That kind of reversal of national course does not frequently occur in history, but neither is it unknown. What the American people would do with themselves in the ination was a fascinating mystery. The weaving of history is a spectator sport. It is a play without a director. No man, not even kings or presidents or prime ministers, is much more

262

than a spectator to the events and sometime bit player. It is reminiscent of Tolstoy's observations on how grand an illusion it was that even the commanding general was in command of the battle. You and I are audience. These nal words are not an epilogue, as they would be if the play were over, but a sort of parting word at intermission and a reminder that we may see one another again in the audience to the remaining scenes. There is not much that we can do about the play except to know how we would reply if we were called upon to speak or vote from the audience. After you have thought that out, come and join me in the galleries and we will watch.

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